Reckless credit practices at Washington Mutual Bank were detailed Tuesday at a hearing held by a Senate subcommittee investigating the role of high-risk home loans in the financial crisis. The collapse of WaMu, which specialized in risky "option ARM" loans that many of its mortgage holders were unable to pay, helped send the financial markets into a tailspin.
Washington Mutual "was a reflection of the mortgage industry, characterized by very fast growth, rapidly expanding product lines, and deteriorating credit underwriting," James Vanasek (pictured), chief risk officer of WaMu in 2004 and 2005, testified to the subcommittee.
"Mistakes Were Made"
"This was a hyper-competitive environment in which mistakes were made by loan originators, lending institutions, regulatory agencies, rating agencies, investment banks that packaged and sold mortgage-backed securities, and the institutions that purchased these excessively-complex instruments," Vanasek said.
The bank's failure was "both the result of individual failures and systemic failures fueled by self-interest, failure to adhere to lending policies, very low interest rates, untested product innovations, weak regulatory oversight, astonishing rating agency lapses, weak oversight by boards of directors, a cavalier environment on Wall Street, and very poorly structured incentive compensation systems that paid for growth rather than quality."
Vanasek also blamed the repeal of Glass Steagall Act, which had separated banking from securities brokerage and other financial institutions, and its impact on the securitization market, as well as Community Reinvestment Act requirements that put pressure on banks to make more low-income mortgage loans.
Vanasek testified that he was unable to change the bank's culture of issuing large volumes of poor loans that were then securitized and sold to investors. His efforts to tighten the rules, including verifying income information that many borrowers were providing, were ignored, sometimes at the urging of mortgage officers eager to earn high fees on the loans they made.
A Man-Made Disaster
"To rebuild our defenses it is critical to understand that the recent financial crisis was not a natural disaster," said Sen. Carl Levin, chairman of the Permanent Subcommittee on Investigations, a part of the Homeland Security and Governmental Affairs Committee. "It was a man-made economic assault. People did it. Extreme greed was the driving force, and it will happen again unless we change the rules."
In the last 18 months the subcommittee has conducted more than 100 interviews and depositions to investigate the cause of the economic crisis, developing case studies that are detailed in 86 exhibits on its website. The subcommittee's investigation focused on the period from 2003-2008 leading up to the financial crisis.
While the now-failed WaMu, which at one point was the sixth largest bank in the U.S. with $330 billion in assets, had once made conservative, traditional fixed-rate mortgages, in 2005 the bank moved to more profitable option-ARM and subprime mortgages, Levin said. In 1999 purchased Long Beach Mortgage Company, a subprime lender who made loans to people whose credit histories did not support getting traditional mortgages.
Long Beach made the loans through third-party mortgage brokers, and then the company packaged and sold the loans to Wall Street as mortgage-backed securities. Levin detailed ongoing problems with fraud and shoddy loan practices at Long Beach, which were not stopped by WaMu.
"Long Beach was not a responsible lender," Levin said. "Its loans in mortgage-backed securities were among the worst performing in the subprime industry." Emphasis at both Long Beach and WaMu was put on churning out large volumes of the highly profitable subprime loans, which were sold as to Wall Street as mortgage-backed securities.
Levin cited an internal email of WaMu's primary federal regulator, the Office of Thrift Supervision, stating that Long Beach mortgage-backed securities prior to 2003 "have horrible performance. LBMC finished in the top 12 worst annualized net credit losses in 1997 and 1999 through 2003," and the company had poor performance other years as well. The Federal Deposit Insurance Corp. also noted numerous deficiencies in the company's loans.
Nevertheless, the company was allowed to securitize its loans, selling them to investors, and neither WaMu nor regulators took decisive action to stop the company from continuing to issue the highly profitable subprime loans.
"Confidence was king" at WaMu when it dived head-first into high-risk lending, said Sen. Tom Coburn, R-Okla., ranking member of the subcommittee. "The bank drastically altered its business model from long-term fixed-rate mortgages to higher-risk loans made to higher-risk borrowers," he said. Easy money from the Federal Reserve and climbing home values gave company executives a misplaced sense of confidence, he said.
Sales associates were put under immense pressure to "just get the loans done," Coburn said. Coupled with a voracious appetite for subprime-based mortgage backed securities from Wall Street and government sponsored enterprises Fannie Mae and Freddie Mac, "all the pieces were in place for an epic fall of this once venerable financial institution." WaMu "made sure anyone and everyone got a loan," he said.
Congress also failed to oversee Fannie Mae and Freddie Mac, the Federal Reserve, the FDIC, the Securities and Exchange Commission, and other areas as well, Coburn said. "Because of reckless federal policies too many families found themselves locked into mortgages they did not understand and absolutely could not afford."
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