Wa Mu collapsed, no prosecution of bankers

Washington Mutual bank collapsed in 2008, the largest bank failure in U.S. history.  It was the beginning of the banking failures that created the economic crisis.

Last week the Federal Deposit Insurance Commission agree to a 64.7 Million settlement and no prosecution of Wa Mu executives.

WA Mu  finally came crashing down on September 25, 2008. After one hundred-plus years of stable steady growth and expansion, ten years of aggressive acquisitions and record profits and one tumultuous year of disaster, the US Office of Thrift Supervision seized Washington Mutual Bank from its holding company after banking hours and placed it into Federal Deposit Insurance Corporation receivership. With rumors of its potential demise spreading, depositors withdrew $16.7 billion in 9 days , crippling the company’s liquidity and ability to act as a going concern. JPMorgan subsequently purchased the bank’s assets and deposits for $1.9 billion, less than a third of what was offered earlier in the year (in stock) and turned down by WaMu’s board .

Washington Mutual’s collapse was the largest bank failure in U.S. history; when large banks fail many other stakeholders are affected, and many parties contributed to the problems that brought WaMu down. The class action complaint brought by Bernstein Litowitz Berger & Grossmann LLP on behalf of investors offers a tremendous array of insider testimony and inside information about WaMu’s operations during the period 2005-2008; it is of such high quality, breadth and scope that it will be the primary source for this analysis. Defendants include top WaMu executives, directors, underwriters of securities offerings, and Deloitte Touche Tohmatsu, a Big 4 accounting firm.

Deloitte is accused of violating Section 11 of the Securities Act of 1934 by offering unqualified auditor’s reports attesting to the accuracy of financial statements incorporated into securities offerings made in 2006 and 2007.

Deloitte failed WaMu, and WaMu failed the public. Direct investors in Wamu securities and related derivatives lost substantial sums, and have procedural avenues to claim relief from these losses, whatever their worth. The public has yet another high-profile auditing failure, loss of confidence in the market, and no directly effective remedy. It could be useful to examine the lessons from WaMu and Deloitte’s failure: the decisions that brought them to collapse, the warnings ignored, the laws broken, and what this bank failure says about the audit industry.

WaMu’s “Whoo Hoo” Mortgage Business

According to many former employees of WaMu, the culture and focus of the bank began to change in 2005 with the placement of a new senior management regime. Stephen Rotella joined WaMu as president and COO and acted as president of the Home Loans Group until David Schneider took the position in mid-2005. WaMu also appointed a new Chief Enterprise Risk Officer (Ronald Cathcart) and a new Controller (John Woods) at this time . After 2000 and especially after the transition in leadership in 2005 WaMu’s focus became residential lending and related products as a driver of asset accumulation and interest income. In 2006 and 2007 nearly 70% of interest income and 60% of overall average assets were generated by residential real estate loans either originated by WaMu and held or sold or loans and mortgage-backed securities purchased for investment . This was no accident; WaMu’s new management team had very clearly focused on aggressive tactics to capture market share in residential real estate, offering a new 5 year plan in February 2005 intent on “transforming the company's mortgage business and maintaining a leading national position in mortgage lending…” .

WaMu focused sales efforts on subprime lending and nontraditional products such as interest-only, 80/20, Option ARM and adjustable-rate loans. Mortgage lending had undergone something of a sea change since the last downturn in housing ended in the early 1990s. After the dot-com bubble burst in 2000 low interest rates, stagnant real wages, population growth and rapid appreciation made housing an attractive investment sector for quick cash and equity gains. Expanded markets in securitizing and trading of loans meant that a bank like WaMu could be aggressive in originating loans and earning origination fees without having to hold them in-house and take the attendant risks; lenders could securitize the loans and sell them to third parties as quickly as they could procure them. Highly potentially profitable interest-only, teaser, and especially Option ARM loans overtook traditional fixed-rate mortgages in the WaMu portfolio; Option ARMs themselves represented over 50% of WaMu’s portfolio from Q3 2005- Q2 2008 . Option ARM loans allowed the borrower to make a “minimum” payment below the interest due; the difference would negatively amortize into the principal until “recasted” into a new payment structure after hitting a ceiling of 110-125% of origination amount.

Some WaMu employees interviewed for the class action complaint described the residential mortgage operations as “crooked” and “underhanded” . According to numerous witnesses loan salespeople were often unqualified or uninterested in ensuring that borrowers understood the terms of their loans; Confidential Witness 5 believed that “the majority” of Option ARM borrowers did not understand that their rate and payments would go up after the teaser period (Complaint p. 38). Repeatedly in the complaint employees stated that policy dictated from the highest levels encourage aggressive selling, wholesale noncompliance with company underwriting standards, fictitious appraisals, and “tremendous pressure from the sales guys to approve loans” and that, with the involvement of WaMu management, even questionable loans “usually got taken care of one way or another.” (Complaint p. 36).

Underwriting and risk management standards were materially weakened or ignored with increasing fervor during the period beginning in 2005. Confidential Witness 17, a former Senior Vice President of Enterprise Risk Management, “explained that various Risk Reports were delivered to WaMu’s senior management – including at least Defendants Rotella, Cathcart and Casey – during 2006 ‘specifically quantified the fact that the Company was exceeding certain risk parameters as dictated by [WaMu’s] risk guidelines’” (Complaint p. 44). CW 17 said the methodology that was being used to analyze risk was inadequate and that pleas for corrective action “were overruled” (Complaint p. 44). CW 17 and other senior, experienced risk management leaders chose to leave the company during the class period rather than be parties to the policies being directed by top-level executives. A memo issued by the Chief Compliance and Risk Oversight Officer in October 2005 spelled out the new model, in case employees had failed to grasp it: from then forward Risk Management would be a “customer-service, supporting function” rather that imposing a “regulatory burden” on other Company segments (emphasis mine) (Complaint p. 45-46).

In 13 Banks: The Wall Street Takeover and the Next Financial Meltdown,  Johnson and Kwak  argue that in the crisis of 2007/2009, which the oligarchy  created, the rich seized billions of dollars for themselves.  They made massive profits from the economic disaster. The great Recession cost  the homes, the jobs, and even the lives of working people.

 In  The Wall Street Takeover and the Next Financial Meldown,  Johnson and Kwak describe in detail the self serving economic theories which the wealthy and the powerful promote, such as those advanced most notably by the University of Chicago economists.  These theories known at various times as Free Market Capitalism, or the Washington Consensus, or the rational market thesis  serve the elite well.   Allowing these theories to disguise market manipulation by the large banks  is  very profitable  for the Oligarchy while it  impoverishes  working people and assault unions.

Wall street’s actions, led by WaMu  plunged the U.S. into the worst financial crisis since the Great Depression, destroying jobs and lives.  Despite receiving tax payer bailouts, leading banks have continued to not lend, they have used the bailouts for their personal benefits through bank bonuses, and they have refused to modify home mortgages.

While millions of working people have continued to lose  their jobs, their homes, their health care, and their futures, it is return to business as usual for Wall street firms, return to casino capitalism.

Note:  House Concurrent Resolution  85. Dec. 2011.

Resolved by the House of Representatives (the Senate concurring), That it is the sense of the House of Representatives that any action taken by the Department of Justice should be consistent with the following goals:

(1) The mortgage servicers who engaged in fraudulent behavior should not be granted criminal or civil immunity for potential wrongdoing related to illegal mortgage and foreclosure practices.

(2) The Federal Government and State attorneys general should proceed with full investigations into claims of fraudulent behavior by mortgage servicers.

(3) Any financial settlement reached with mortgage servicers should appropriately compensate for, and accurately reflect, the extent of harm to all victims, including homeowners and State pension beneficiaries, caused by the mortgage servicers’ fraudulent behavior.

They are doling out record pay and bonuses to their executives.

The banks CEOs should be prosecuted for criminal fraud, and  the banks should be made to pay by a transaction tax on stocks, equities, and trade instruments such as derivatives. Perhaps most important is to understand that the system has not been fundamentally changed – it will all happen again.  Johnson and Kwak note

 “ In the dark days of late 2008- when Lehman Brothers vanished, Merrill Lynch was acquired, AIG was taken over by the government, Washington Mutual and Wachovia collapsed, Goldman Sachs and Morgan Stanley fled for safety morphing into bank holding companies, and Citigroup and Bank of America teetered on the edge of being bailed out- the conventional wisdom was that the financial crisis  spelled the end of an era of excessive risk –taking and fabulous profits.  Instead,  we can now see that the largest, most powerful banks came out of the crisis even larger and more powerful.  When Wall Street was on its knees, Washington came to its rescue- not because of personal favors to a handful of powerful bankers, but because of a belief in a certain kind of financial sector so strong that not even the ugly revelations of the financial crisis could uproot it.”  ( P.11)

To see more on this see, “The easiest way to rob a bank is to own one,” on a prior post.