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Home > Blogs > Anthony Harrington > The demise of Washington Mutual: US Senate Report into the crash, part 3

The demise of Washington Mutual: US Senate Report into the crash, part 3

Loan securitization | US Senate Report into the crash – part 3 Anthony Harrington

This is the third of four blog posts on the US Senate report on the crash. See also: The US Senate report on the crash (part 1), “Criminalization” of America’s financial system? (part 2), and Recommendations—Will regulation work this time? (part 4).

Part 1 looked at the scale of the evidence the US Senate trawled through to compose its 650 page report into the Wall Street Crash. Part 2 looked briefly at the way the report has been received and touched on the attack by the Senators on Goldman Sachs particularly. In part 3 I want to concentrate on the case study the Senate report provides of the demise of Washington Mutual (WaMu).

As the Senate Investigations Sub Committee Chairman Carl Levin notes, WaMu held itself up as a prudent bank. “In reality it was nothing of the kind,” he says. “So what’s new?” jaded readers might reply. “Just goes to show they were all at it!” Actually, what is new is the depth of the investigation carried out by the Committee which really highlights how standards at WaMu slipped and the bank lost its bearings as it chased riskier and riskier mortgage deals, turning into the biggest bank failure in US history. It is worth giving the Committee’s summary in its entirety:

“At the time of its failure, WaMu was the nation’s largest thrift and sixth largest bank, with $300 billion in assets, $188 billion in deposits, 2,300 branches in 15 states, and over 43,000 employees. Beginning in 2004, it embarked upon a lending strategy to pursue higher profits by emphasizing high risk loans. By 2006, WaMu’s high risk loans began incurring high rates of delinquency and default, and in 2007, its mortgage backed securities began incurring ratings downgrades and losses. Also in 2007, the bank itself began incurring losses due to a portfolio that contained poor quality and fraudulent loans and securities. Its stock price dropped as shareholders lost confidence, and depositors began withdrawing funds, eventually causing a liquidity crisis at the bank. On September 25, 2008, WaMu was seized by its regulator, the Office of Thrift Supervision, placed in receivership with the Federal Deposit Insurance Corporation (FDIC), and sold to JPMorgan Chase for $1.9 billion. Had the sale not gone through, WaMu’s failure might have exhausted the entire $45 billion Deposit Insurance Fund.”

What possessed normally sensible senior bankers in WaMu to go on this profit hunting binge, to the extent of carrying out the origination and securitization of hundreds of billions of dollars in high risk, poor quality mortgages? Internal auditors and fraud investigators like to say that there is no such thing as a small fraud. Every small fraud is a big fraud that just needs time to grow. As the Committee points out, over a four year period, these dodgy loan securitizations grew and grew as a percentage of WaMu’s total securitization activities. Four years before the bust, in 2003, these loans already accounted for 19% of its securitizations. By 2006 they had risen to 55% while the amount of low risk, fixed rate loans the Bank was writing had dropped from 64%, (not exactly a prudent level, but not totally off the wall either), to just 25% of its origination.

WaMu’s sub-prime lender, Long Beach Mortgage Corporation, dived into the sub-prime market as if the good times would never end. From 2000 to 2007 the two securitized “at least $77 billion in sub-prime loans”. Then there was the high risk home equity product the bank went in for. This rose to $67 billion, or 27% of its home loan portfolio, up 130 percent on 2003. This is “irrational exuberance” gone bonkers. I am reminded of the limerick about the fine young lady from Niger, who went for a ride on a tiger. Washington Mutual executives knew that the beast they were riding was out of control, but by that stage, there was no way back. Once the flood has you, it sweeps you to your personal Niagara Falls at breakneck speed. WaMu bankers thought that securitization pushed the risk off their books and they saw that high risk securitizations generated high sales prices from investors who wanted the high rate of interest associated with high risk coupons. Everyone got rich, until they didn’t.

So what was the regulator, the unlamented Office of Thrift Supervision, doing while all this was going on? This forms the second case study carried out by the Senate sub-committee. The short answer, of course, is “nothing”!  It saw that things were wrong but it did not have the intestinal fortitude to grab the bankers by the short hairs and force them to mend their ways:

Over a five year period from 2004 to 2008, OTS identified over 500 serious deficiencies at WaMu, yet failed to take action to force the bank to improve its lending operations and even impeded oversight by the bank’s backup regulator, the FDIC… until shortly before the thrift’s failure in 2008 the OTC continually rated WaMu as financially sound.

Put this combination of a timid regulator and bankers whose feet have completely left the ground together, and you have a completely toxic scenario. Will the Senate sub-committee’s report give us sounder regulation next time round? That, as they say, is anyone’s guess.

Further reading on loan securitization and the crash:

Tags: high risk loans , Office of Thrift Supervision , securitisations , Senate Investigations Committee , Senator Carl Levin , US Senate Report , Wall Street , Washington Mutual
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