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WaMu's Failure Was Fueled By Fraud and Greed: Panel

Monday, 12 Apr 2010 | 5:26 PM ET

Once the nation's largest thrift, Washington Mutual became a Main Street bank in search of Wall Street profits.

Washington Mutual's headquarters in Seattle.
AP
Washington Mutual's headquarters in Seattle.

It's a quest that led employees to engage fraud, and ultimately led to WaMu's failure in September of 2008, a Senate subcommittee alleges.

Along the way, the thrift infected the secondary mortgage market with billions of dollars in bad loans.

Those are the findings of year and a half long investigation by the Senate Permanent Subcommittee on Investigations.

The panel is holding the first of four hearings Tuesday on the role high risk mortgages played in the financial crisis.

"Using a toxic mix of high risk lending, lax controls and destructive compensation practices, Washington Mutual flooded the market with shoddy loans and securities that went bad," the subcomittee's Chairman Carl Levin (D-Mich), said in a statement.

Levin said his subcommittee looked at the Seattle-based thrift as a case study.

He described it as the story of a 100 year old traditional lender that turned away from safer lending practices to pursue the higher profits reaped from selling high risk mortgages to Wall Street firms.

As it did, the thrift failed repeatedly to bring the hammer down on fraudulent practices rampant in some of its most profitable mortgage centers.

Starting in 2003 WaMu began increasing the production of subprime loans.

At the time, Wall Street firms were buying these mortgages, bundling them together, slicing them into pieces and selling them to yield-hungry investors in a process known as securitization.

Despite the underlying nature of the loans, the securitized products often received triple A ratings from credit rating agencies.

Ex-WaMu Execs on Capitol Hill
A year-and-a-half-long investigation found the road to Washington Mutual's failure was paved by top executives who did little to stop fraudulent practices at the thrift. CNBC's Mary Thompson has the full story.

All that changed in January 2008 when the same agencies started downgrading the securities as home prices declined and defaults increased. Banks saddled with the securities lost billions of dollars, bringing the U.S. economy to the brink of collapse.

"There was a huge appetite that Wall street had for these mortgages," Levin said. "It changed this character of this Main Street bank into a production factory for Wall Street and Wall Street securities."

Levin said his subcommittee will leave questions of criminality to the Justice Department, and will turn the investigations findings, including over 500 pages of documents and emails over to the Financial Crisis Inquiry Commission. The FCIC is investigating the causes of the financial crisis.

Levin said he hopes the subcommittee's findings will give a boost to strong regulatory reforms through a robust consumer protection agency.

As for Washington Mutual's primary and secondary regulators, the Office of Thrift Supervision and the FDIC, they will answer questions about their role in a hearing on Friday.

While WaMu began expanding its subprime lending practices in 2003, it didn't receive formal board approval until January 2005, doing so at the behest of regulators.

The architect of this new strategy was former CEO Kerry Killinger. He ran the thrift for almost 18 years until he was fired in September of 2008.

Faked Documents: Panel

One way WaMu pursued this market was through its subprime lender, Long Beach Mortgage Corporation. In 2006, WaMu securitized $29 billion of the subprime loans purchased by the California-based business, up from the $4.5 billion in 2003.

From 2000 to 2007, the thrift securitized a total of $77 billion of these mortgages even though WaMu shut down securitization at Long Beach for three months in 2003 because of concerns about the poor quality of these loans.

A followup report dated Jan. 13, 2004 by the FDIC and Washington state banking regulators reviewed 4,000 of the warehoused Long Beach loans and found only 950 or 25% were saleable, 800 were unsaleable and the remaining 3,245 contained defiencies "requiring remediation prior to sale."

Senior management, including the head of the bank's home lending business, Dave Schneider were aware of these deficiencies then and emails dated as late at September of 2007 show management was aware the loans being sold for securitization were deficient, yet they didn't shut the operation down.

The problems extended beyond Long Beach's loans into WaMu's prime lending practices.

The thrift's signature product was an "Option ARM" mortgage. With these loans, borrowers would pay an initial teaser rate then select one of four options for paying down the rest of the loan: a traditional 30 year fixed rate mortgage, a 15 year fixed rate loan, an interest only loan, or a loan requiring a minimum payment that didn't cover the monthly intest on the loan.

The unpaid interest was then added to the loans as principal putting the borrower deeper in debt.

According to the subcommittee's findings a 2005 internal probe of two of WaMu's most profitable branches in Montebello and Downey, California found that 58% and 83% of the loans coming out of the offices were fraudulent, meaning they lacked proper documentation or false information about the borrower's income and ability to repay the loan.

Schneider was told, though no action was taken by bank management to correct or end these practices.

The problem was so bad, in june of 2007 AIG refused to insure the mortgages coming out of Montebello.

AIG waited for three months, expecting a reply from Washington Mutual and when it hadn't received one three months laster, notified the California insurance regulator and the Office of Thrift Supervision about the problems.

In another branch in Westlake, CA employees would manufacture documents for prospective borrowers by cutting and pasting bank documents from current clients. The subcommittee alleges they did this speed the approval process.

The employees were paid by the number of loans they generated, not the quality of loans the originated. The branch was shut down in April of 2008.

Among the witnesses at tomorrow's hearing, Killinger, Schneider, WaMu's former president and COO Stephen Rotella and two former chief risk officers.

After spearheading WaMu's transition from a regional powerhouse into a national force, shareholders voted to oust Killinger as Chairman during a contentious shareholders meeting in April of 2008.

Ex-WaMu Execs on Capitol Hill
A year-and-a-half-long investigation found the road to Washington Mutual's failure was paved by top executives who did little to stop fraudulent practices at the thrift. CNBC's Mary Thompson has the full story.

This came after the firm had reported losses in the billions in mortgage related losses for two consecutive quarters.

Killinger eventually reliquished the role of Chairman and was fired by the board right before the FDIC took over the bank in September of 2008. For that year, he was paid $25 million in compensation.

The FDIC took action on WaMu following the failure of subprime lender Indymac in July of 2008. This caused a run on WaMu. Fearful its exposure to risky mortgages would be its undoing, depostors withdrew $9 billion from the bank.

In September of 2008, The FDIC stepped in, took over the bank and sold its banking assets to JP Morgan for $1.9 billion dollars in what many consider to be the biggest steal of the financial crisis.

For the FDIC, this move saved it having to cover the $180 billion in deposits held by the bank, something that would have bankrupted its insurance fund.

WaMu's demise also came at a significant cost for the private equity firm TPG. It had invested $7 billion in the troubled thrift, losing all of it when WaMU failed.

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