Preventing the Washington Mutual (WaMu) Crisis

Thousands of papers and articles have been written about the 2008 recession, but most don’t mean much to the ordinary citizen unless it personally affects you. Washington Mutual’s demise is personal to me because it was my bank prior to its bankruptcy. Looking back at the years prior to this, its end was easy to see. I remember going into my local branch in 2015 to deposit my weekly paycheck. I worked for Bank of America as a teller and made $10 an hour. Since it was a small branch, I only worked 25 hours, so my weekly take home was about $230. The teller at Washington Mutual told me I would get approved if I wanted a credit card. Her confidence was reassuring (but looking back, it was a red flag). I agreed to apply and in less than 5 minutes, I was approved. Washington Mutual gave a pat time employee with no credit and a job that paid about $12,000 a year, a credit card with a credit limit of about $1500! It was that easy.

The purpose of this article is to analyze actions Washington Mutual (WaMu) could have taken to prevent its bankruptcy and eventual demise as the biggest Savings and Loan. By the time WaMu was sold off to JP Morgan for a giveaway price of $1.9 billion, it had gone to the record books as the largest demise of a US company, surpassing the record held by another unethical company, Enron. Washington Mutual was one of the largest banks in the US by 2007 with $307 billion in assets, more than 43,000 employees, 2,200 branch offices in 15 states. Nearly 60% of its business came from retail banking, 20% from credit cards, 14% from home loans and 6% from commercial lending. Its biggest customers were individuals and small businesses.

The home loan business caused it downfall as WaMu engaged in subprime loans that led to enormous losses. WaMu reported a net loss of $67 billion for 2007, after just reporting a profit of $3.6 billion for 2006 (Amadeo, 2016). WaMu only wrote 20% of its mortgages at​ greater than 80% loan-to-value ratio. But by the end of 2007, many loans were more than 100% of the home's value. As the great recession began to spread with businesses failing, depositors unsure of the financial position of WaMu rushed to the bank to make withdrawals of $16.7 billion out of their savings and checking accounts over a ten day period (It was about 10% of WaMu's deposits), the Federal Deposit Insurance Corporation (FDIC) said the bank had insufficient funds to conduct day-to-day business, it seized and sold it to JP Morgan Chase for $1.9 billion.

Washington Mutual had failed primarily because of management’s pursuit of high-risk lending strategy that included liberal underwriting standards and inadequate risk controls. The strategy accelerated in 2005 and came to a crashing end in 2007 with the drop in the housing market. WaMu was technically fine until August 2007, when the secondary market for mortgage-backed securities (MBS) disappeared. WaMu could not resell these mortgages. The housing decline meant it couldn't sell new mortgages and take in new cash. By Q4 2007, it had to write-off $1.6 billion in defaulted mortgages. It also had to set aside additional cash to provide for future losses, resulting in a total net loss for the quarter of nearly $2 billion.

After purchasing WaMu, JP Morgan had to write down $31 billion in bad loans. It also needed to raise $8 billion in new capital to keep the bank going. WaMu had pooled 1,900 loans worth more than $1 billion in a security in March 2007. Within 9 months, the ratings on the loans were downgraded and by February 2010, more than half the loans were delinquent (Health, 2011).

Actions that could have helped/saved the bank

Selling to a worthy buyer on time:

JP Morgan had tried to buy WaMu in the Spring of 2008 due to its innovative retail banking concept and was turned down by the bank in favor of private equity. JP Morgan had offered to acquire WaMu in an unassisted transaction for $8 a share. At this point, the bank was still very valuable and selling it would have prevented losses suffered by investors, employees, and management. With $307 billion in assets, it would later be sold to the same bank for a merger $1.9 billion!

Getting rid of bad Management:

Per Lowenstein (2010), “But with the possible exception of Angelo R. Mozilo of Countrywide Financial Corp., arguably no banking executive did more harm to the fabric of the U.S. mortgage industry like Kerry Killinger, the former CEO of WaMu” (para. 5). Killinger grew WaMu from a middle size company to a large bank by issuing loans, seemingly without regard to whether the borrower could repay them; loan officers were discouraged from soliciting information from applicants; a company flier with the catchy and revealing motto "a thin file is a good file" urged them to keep interviews brief. The board of directors did not intervene if profits were being made, such intervention could have saved the company from collapse. By the time he was fired, the company had lost so much that it could stand the test of time. Alan Fisherman, the new CEO after Killinger was hired on September 8, 2008 (three weeks before they company was sold to JP Morgan). WaMu threw a $7.5 million bonus at Fishman when it hired him and guaranteed him an immediate cash severance of $11.6 million. He made $20 million in 3 weeks of work! He also was eligible for annual bonuses of up to 365 percent of his annual base pay — set at $1 million.

Independent Compliance Officers

WaMu should not have been involved in risky lending practices. It also had other leadership issues include poor mid-level management, inadequate information systems and risk-management controls — even widespread fraud. At one point in 2007, the bank had run through nine chief compliance officers in just seven years. The bank's chief compliance and risk oversight officer were drafted into the effort to push loans out the door. Risk personnel at WaMu were to play a "customer service" role and to avoid imposing a "burden" on loan officers. Having compliance officers or internal auditors with leeway and freedom could have prevented the financial crises in the bank.

Liquidity

WaMu’s key pressure point when over $16 billion of deposits were withdrawn during one critical week — would have been strengthened under Basel III's "liquidity coverage ratio," which requires at least a 30-day liquidity buffer. If WaMu had enough liquidity set aside, it could have weathered the storm.

Aggressive Growth

And perhaps most important, as WaMu embarked on its aggressive growth strategy in subprime lending in 2004 which led to over $30 billion of exposure versus tangible common equity of about half that amount. This could have been curtailed or prevented but was continued till 2008. An effective manager would have stopped the exposure to such as risk.

Adjustable-rate mortgage/MBS

WaMu’s involvement in these kinds of mortgages were the main reasons for its demise. A good CEO would have insisted on down payments, stringent investigation of applicant’s job, employment history, financial record, and credit score before lending them money. Instead, WaMu became a leader in issuing adjustable-rate mortgages and, especially, mortgages in which the borrower could defer a portion of the interest due. Naturally, such mortgages were popular because the initial monthly payments were low. But since part of the interest was deferred, the homeowner fell further into debt month after month. Such mortgages were a trap almost guaranteed to result in massive foreclosures.

Adequate regulation

According to O’Donnell (2016), at the start of the crisis, WaMu had risk-weighted assets of over $240 billion, tangible common equity of $16 billion and ultimately over $31 billion of subprime mortgage losses. If Washington Mutual had been regulated to current standards and rules:

a) Risk-weighted assets would likely have been closer to $260 billion under the more conservative Basel III rules.

b) Tangible common equity would likely have been closer to $26 billion.

c) The combination of capital and bail-in debt would have been closer to $52 billion (20% of risk-weighted assets).

The role of Glass-Steagall Act

Savings and Loans were prohibited by the Glass-Steagall Act from investing depositors' funds in the stock market and high-risk ventures to gain higher rates of return. The Clinton Administration repealed Glass-Steagall to allow U.S. banks to compete with more loosely regulated international banks. This allowed banks to use FDIC-insured deposits to invest in risky derivatives.

Unbiased Regulators

Regulators failed for years to properly supervise the giant savings and loan Washington Mutual, even as the company wobbled under the weight of risky subprime mortgages (Chan, 2010). FDIC, which had questioned the Office of Thrift Supervision’s assessments of the bank’s soundness, could have stepped in earlier and acted as the primary regulator, but decided. The Office of Thrift Supervision which derived 15% of its revenue from WaMu from assessments consistently deemed the bank “fundamentally sound,” giving it a rating of 2, the second highest rating and did not lower the rating to 3 (“exhibits some degree of supervisory concern”) until February 2008, and to 4 (“unsafe and unsound”) until September 2008, days before WaMu collapsed. If OTS was unbiased and FDIC had taken a hard line on OTS, WaMu could have been saved earlier on rather than the bickering between the that allowed WaMu to fail.

References

Amadeo, K. (2016). Washington Mutual Bankruptcy: The Story Behind the Largest Bank Failure in History. Retrieved from https://www.thebalance.com/washington-mutual-how-wamu-went-bankrupt-3305620

Chan, S. (2010)). U.S. Faults Regulators Over a Bank. Retrieved from http://www.nytimes.com/2010/04/12/business/12wamu.html?ref=todayspaper

Fox News (2008). WaMu Gives New CEO Mega Payout as Bank Fails. Retrieved from http://www.foxnews.com/story/2008/09/26/wamu-gives-new-ceo-mega-payout-as- bank-fails.html

Grind, K. (2012). The Inside Story of WaMu - The Biggest Bank Failure in American History. Retrieved from http://www.cnbc.com/id/47874555

Health, D. (2011). WaMu, other banks motivated by greed, financial crisis probe concludes. Retrieved from https://www.publicintegrity.org/2011/04/13/4147/wamu-other-banks-motivated-greed-financial-crisis-probe-concludes

Lowenstein, R. (2010). Kerry Killinger, the man who destroyed WaMu. Retrieved from http://articles.latimes.com/2010/apr/16/opinion/la-oe-lowenstein16-2010apr16

O’Donnell (2016). WaMu’s Collapse Wouldn't Have Happened with Today's Regulatory Landscape.