WASHINGTON, D.C. -- The former CEO of Washington Mutual, the biggest U.S. bank ever to fail, on Tuesday defended the bank's actions to reduce risks from the looming housing bust.
Kerry Killinger, who led the Seattle-based thrift, also argued that WaMu had adequate capital and shouldn't have been seized by the government in September 2008. The bank "should have been given a chance to work its way through the crisis," Killinger said in testimony prepared for a hearing by a Senate panel.
But two former chief risk officers of Washington Mutual said they tried to curb risky lending practices by the bank and ran into resistance from top management when they brought their concerns to them.
As the housing bust deepened in late 2007 and early 2008, "I was increasingly excluded from senior executive meetings and meetings with financial advisers when the bank's response to the growing crisis was being discussed," Ronald Cathcart, who helped oversee risk until April 2008, testified at the hearing. By January 2008 he was "fully isolated" and was fired by Killinger a few months later, Cathcart said.
The other risk officer, James Vanasek, testified that he tried repeatedly to limit the percentage of high-risk loans for borrowers who were unlikely to be able to repay and the number of loans made without verifying borrowers' income. But his efforts fell flat "without solid executive management support," Vanasek said.
Former WaMu executives are appearing before Congress for the first time since the bank's collapse. Their testimony follows the panel's 18-month investigation, which found that WaMu's lending operations were rife with fraud and that management failed to stem the deception despite internal probes.
Sen. Carl Levin, D-Mich., the chairman, has said the panel won't decide until after the hearings on Tuesday and Friday whether to make a formal referral to the Justice Department for possible criminal prosecution. Justice, the FBI and the Securities and Exchange Commission opened investigations into Washington Mutual soon after its collapse in the fall of 2008 at the height of the financial crisis.
In his testimony, Killinger says it was "unfair" that Washington Mutual didn't get the benefits of government actions that helped other financial institutions in the days of the crisis in the fall of 2008. He was referring to steps such as a doubling of the limit on deposit insurance to $250,000 and new federal guarantees for bank debt.
Between 2003 and 2007 under his tenure, WaMu cut in half its staff in the home loans division and sold 30 percent of its portfolio of loans, Killinger says in his testimony.
Killinger is appearing at the hearing with ex-president and chief operating officer Stephen Rotella, and David Schneider, who was the highest-ranking executive in the bank's home lending operation. Two former chief risk officers of the bank also will testify.
WaMu's pay system rewarded loan officers for the volume and speed of the subprime mortgage loans they closed on. Extra bonuses even went to loan officers who overcharged borrowers on their loans or levied stiff penalties for prepayment, according to a report released Tuesday by the investigative panel of the Senate Homeland Security and Governmental Affairs Committee.
"Washington Mutual engaged in lending practices that created a mortgage time bomb," Levin said at the start of Tuesday's hearing. "WaMu built its conveyer belt of toxic mortgages to feed Wall Street's appetite for mortgage-backed securities. Because volume and speed were king, loan quality fell by the wayside."
The new report by the Senate investigators said the top WaMu producers, loan officers and sales executives who made high-risk loans or packaged them into securities for sale to Wall Street, were eligible for the bank's President's Club, with trips to swank resorts—like Maui in 2005.
Fueled by the housing boom, Seattle-based Washington Mutual's sales to investors of packaged subprime mortgage securities leapt from $2.5 billion in 2000 to $29 billion in 2006. The 119-year-old thrift, with $307 billion in assets, failed in September 2008. It was sold for $1.9 billion to JPMorgan Chase & Co. in a deal brokered by the Federal Deposit Insurance Corp.
WaMu was one of the biggest makers of so-called "option ARM" mortgages. They allowed borrowers to make payments so low that loan debt actually increased every month.
The Senate subcommittee investigated the Washington Mutual failure for a year and a half. It focused on the thrift as a case study on the financial crisis.
Senior executives of the bank were aware of the prevalence of fraud, the Senate investigators found.
The investors who bought the mortgage securities from Washington Mutual weren't informed of the fraudulent practices, the Senate investigators found. WaMu "dumped the polluted water" of toxic mortgage securities into the stream of the U.S. financial system, Levin said.
In some cases, sales associates in WaMu offices in California fabricated loan documents, cutting and pasting false names on borrowers' bank statements. The company's own probe in 2005, three years before the bank collapsed, found that two top producing offices—in Downey and Montebello, Calif.—had levels of fraud exceeding 58 percent and 83 percent of the loans. Employees violated the bank's policies on verifying borrowers' qualifications and reviewing loans.
In an episode in 2007, some of WaMu's mortgages were viewed as so suspect by American International Group Inc. that it refused to insure them and complained to both California and federal regulators, according to the Senate investigators. AIG, one of the world's largest insurance companies, itself nearly collapsed in the fall of 2008 and received about $180 billion in bailout aid from the government.
Washington Mutual was repeatedly criticized over the years by its internal auditors and federal regulators for sloppy lending that resulted in high default rates by borrowers, according to the report. Violations were so serious that in 2007, Washington Mutual closed its big affiliate Long Beach Mortgage Co. as a separate entity and took over its subprime lending operations.
In late 2006, Washington Mutual's primary regulator, the U.S. Office of Thrift Supervision, allowed the bank an additional year to comply with new, stricter guidelines for issuing subprime loans.
According to an internal bank e-mail cited in the report, Washington Mutual would have lost about a third of the volume of its subprime loans if it applied the stricter requirements.