Inside Financial Services

The Wrecking of WaMu

Kirsten Grind's account of the bank's decline and fall makes for fascinating reading

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I spent this past weekend finishing The Lost Bank: The Story of Washington Mutual–The Biggest Bank Failure in American History, Kirsten Grind’s behind-the-scenes look at the decline and fall of what was once the country’s third-biggest mortgage lender. While I can’t quite say the book is enjoyable-memories of the financial crisis are still too fresh to comfortably re-live in the kind of detail Grind provides-I couldn’t help but keep turning the pages with a kind of morbid fascination. It’s as if Grind has given us a front-row seat to a massive, slow-motion train wreck, and we simply can’t avert our eyes.

That WaMu ended as a train wreck there can be no doubt. Grind (who covered banking for the Puget Sound Business Journal at the time of WaMu’s failure and who now writes for the Wall Street Journal) doesn’t spend much time telling the story of WaMu’s transformation from a floundering thrift back in the early 1980s into one of the titans of the financial services industry. Rather, she focuses on the events that led to the bank’s collapse and its aftermath. You won’t be surprised to learn that two main factors led to the bank’s demise: the nationwide collapse of the U.S. housing market and poor decisions made by WaMu’s management, led by CEO Kerry Killinger. Even so, it was never inevitable (in Grind’s view, at least) that WaMu was doomed. But the company sure didn’t help itself along the way. Let’s take a look at some of the places where Killinger and Co. went wrong.

Bad Management

As both a sell-side bank analyst and then as an investor, I’ve known Kerry Killinger for many years. I was never as close to him as I am to other bank CEOs, but always respected the success he achieved running Washington Mutual. But even well before the company’s meltdown, it was clear that he’d become too disengaged from the day-to-day details of managing the business. Given the length of Killinger’s tenure, that disengagement might have been inevitable. I’ve always believed in informal term limits for CEOs; Kerry Killinger is a good example of why. He was named WaMu’s CEO in 1989 and remained so until the board finally fired him a few weeks before the company’s collapse in 2008. It would have been tough over those 19 years to not have become complacent running the company. In general, I believe CEOs should step down after 10 years.

Here are some specific examples of what I believe were bad management practices in place under Killinger:

1. The company was managed in separate silos. The retail business and the mortgage business at WaMu were run as distinctly separate entities. Bad idea. For starters, the leaders of those two silos didn’t work well together because they were vying to be Killinger’s successor. Killinger himself ran the company much as Ken Lewis ran Bank of America–without the aid and advice of a small senior management group that was interested in what was best for the company as a whole, rather than individual units. Killinger so hated conflict and confrontation that he didn’t force better teamwork among his senior executives. That was devastating in the end.

2. He was obsessed with Wall Street. Killinger spent years complaining about the lack of respect that WaMu got from Wall Street. That in turn led him to spend an inordinate amount of time setting quarterly earnings expectations–and then fixating on beating them. None of this of course did anything to help strengthen WaMu’s basic business, and very likely weakened it.

3. He overemphasized market share. Like Countrywide’s Angelo Mozilo and BofA’s Lewis, Killinger valued size and market share for their own sakes. In lending, that can be a recipe for disaster, since it can often lead to unwarranted price cuts and an imprudent easing of underwriting standards. In 2000, Killinger established a goal for the company to quadruple its market share in residential mortgage loan originations over five years. That didn’t work out so well.

4. He switched to a higher-risk lending strategy at the wrong time. To boost profitability, Killinger approved a “higher-risk lending strategy” in 2004. In hindsight, this of course proved to be disastrous. There’s no way to know for sure how rigorous the analysis was behind this decision. Then again, since so many other lenders were emphasizing subprime at exactly the same time, it’s hard to believe the analysis was very rigorous at all.

5. Killinger had a history of weak risk management. I believe this is an area where he evolved, in a negative way, over time. As WaMu grew over the years with hardly a hiccup, the importance of risk management was consistently deemphasized-in large part because the CEO tended to downplay it or ignore it altogether.

Washington Mutual failed mainly because of the collapse in housing and the resulting loan losses. But Killinger’s management style and decisions sure didn’t help.

The Mortgage Mess

For better or worse, The Lost Bank also provides an opportunity to re-live some of the worst abuses that led to the housing bubble and its collapse. There’s plenty of blame to go around that’s for sure-even among borrowers. At the peak, 25% of home sales were to “investors” (who often didn’t characterize themselves that way on their loan applications) angling for a highly leveraged windfall with little of their own skin in the game. Then there were the third-party originators who sold loans to Washington Mutual. These people were paid for production, and often resorted to fraud to get it. The stories Grind provides about the lavish parties WaMu threw for members of it “President’s Club”-the company’s biggest in-house mortgage producers-are eye-popping, and harken back to a bygone era. And even there, there was no shortage of shenanigans. It later turned out that 83% of the production of one member of the exalted club, Luis Fragoso, involved fraud.

But besides fraud, much of the blame for WaMu’s demise can be laid at plain, old sloppy underwriting–in subprime loans, prime loans, and home equity loans. The company’s subprime mortgage unit, Long Beach Mortgage, ran into underwriting problems in the early 2000s, actually tightened a little, and then went back to its old habits, resulting in major loan problems beginning in 2005. An internal audit revealed that 99% of Long Beach’s first-payment defaults could have been prevented through sounder underwriting.

But the majority of Washington Mutual’s problem loans were in prime mortgage loans and home equity loans. Grind reports that 70% of the option ARM mortgages and 90% of the home equity loans were underwritten on the basis of “stated income” rather than verified income. Good God!

In hindsight, the housing bubble and its attendant bust are obvious and should have been easily preventable. But so many players made so much money in the boom that they totally miscalculated what would happen once the boom ended.

Detail of the Failure

Grind’s account of Washington Mutual’s final six months is as fascinating as it is sad. One especially interesting part of the story was the epic battle between John Reich, head of the OTS, WaMu’s primary regulator, and the FDIC’s Sheila Bair. There was clearly no love lost between the two. Grind also suggests that WaMu could have been saved if it had been allowed to participate in the TARP programs. Mark me down as skeptical.

But we’ll never know. We do know the company lost $17 billion in deposits in the weeks leading up to its failure and know, too, that it would have suffered massive hits to equity as a result of future credit losses. But other companies did survive, albeit usually via massive dilution to existing shareholders as a result of capital raises. Whether Washington Mutual failed on September 25, 2008 or not, existing shareholders would have taken a huge, huge hit. This movie was going to have a bad ending either way.

A Good Read

The Lost Bank is a great read; it provides background and details to the WaMu saga that will be new to most readers. But as a reminder of the greed and mistakes that created the greatest financial collapse of my lifetime, it’s also more than a little depressing. Enjoy it if you can!

What do you think? Let me know!

16 Responses to “The Wrecking of WaMu”

  1. rivvir

    Don’t know about the book but this article of yours was a good read. Thanks for giving me something over which i can praise you. It’s a refreshing pause.

  2. Bill Dunnell/Seattle/page 124

    You are right Tom, the book is a good yet depressing read. Grind did a real service in telling the story.

  3. brian

    Fabulous commentary, Tom. I too cannot read another book yet on the crisis. Read the Big 3 (Sorkin, Gaspirono, and one other) in 2009 and let it go at that.

  4. Blindspot

    I will try to read it. Those who believe the financial collapse was not caused by a Wall Street debacle of bad underwriting and greed should also read: Thirteen Bankers, The Big Short, House of Cards, Bailout and others. Big banks and Wall Street caused the collapse that led to the “Great Recession” and then got bailouts without having to alter their Boards and or Management which should have been requirements. And the “supposed” “rating agencies” were complicit in knowing knowing how to or merely passing a wand (sp) over MBS’s, CDO’s and other securitizations without digging down to understand and rate their true compositions and risk. They should be thoroughly regulated and should have been be severely fined. And this from a moderate to conservative banker. But what is right is right and politics should play no role in doing the right thing.

  5. Richard

    I, too, was amazed at the lack of reality in the minds of so many executives. One poor decision after another.

  6. Graham Bryce, CEO, Albina Bancorp in Portland, Or

    You made me decide to buy the book, and to write all our dirctors and share your summary. Keep writing-I follow you ever time you do.

  7. FSDA

    WaMu was an amalgum of acquired institutions, so it’s no surprise that the whole never worked as one.

  8. Vegasjoe57

    Good summary Tom; I recall seeing VIC presentations by Whitney and Glenn detailing the credit quality or lack thereof of the borrowers, liar loans, aka, stated income, predominating. Killinger I remember as an ego maniac in denial.
    Similar to WaMu, we have two legacy NC banks that destroyed more wealth of NC citizens than anything in history: Kennedy Thompson and his black hole of $26 billion for Golden West, and Ken Lewis at BOA and his Countrywide toxic investment.
    The 2 NC guys were Napoleonic dwarfs…was Killinger likewise a diminutive midget with a giant ego?

  9. Mark Close

    While it is certainly true that “Washington Mutual failed mainly because of the collapse in housing and the resulting loan losses”, it should be acknowledged that WaMu was one of the primary institutions fueling the housing bubble. They were a big player in both Option-ARMs and piggy-backs to enable buyers to purchase homes where they had no equity committed nor the cash-flow to meet normalized debt service. What could possibly go wrong? There simply couldn’t have been a bubble absent the “innovative” products and lending standards of the WaMus & Countrywides.

  10. The Oinion Letter

    Washington Mutual is a perfect example of how banks today have gotten away from theri original purpose which is to take deposits and lend money (with reasonable requirements and some conservatism) Instead they now want to be bigger and more diversified, a formula which has proven to be disasterous. I could not agree more that CEO’s should be limited to no more than 10 years and in some cases maybe less. Bring back Glass-Steagall, that might help correct some of this foolishness that banks are engaging in.

  11. Mark Close

    While it is certainly true that “Washington Mutual failed mainly because of the collapse in housing and the resulting loan losses”, it should be acknowledged that WaMu was one of the primary institutions fueling the housing bubble. They were a big player in both Option-ARMs and piggy-backs to enable buyers to purchase homes where they had no equity committed nor the cash-flow to meet normalized debt service. What could possibly go wrong? There simply couldn’t have been a bubble absent the “innovative” products and lending standards of the WaMus & Countrywides.

  12. Robert Rogowski

    Tom,

    I agree; it is a good, scary read. Better than Paulson’s book!

    As an IBer with over 70 bank deals done, I see the Achilles heel of Killinger and Co. failing to effectively integrate its deals, especially Long Beach the subprime lender, and sowing the seeds for the demise of WAMU.
    Craig Tall was masterful in doing good deals, but they never really did the right proper integration and lost control of the bank.

    Where was the Board in all this? Corporate governance is another major issue here as the Board should have monitored the risk profile of WAMU over this time period.

  13. Seattle Raptor

    KK was so focused on making the EPS number each quarter that he stalled or killed certain investments in info-tech projects that would have given senior management much better information, primarily on the risk side of the bank. This error was compounded by the acquisition spree of WM which resulted in multiple accounting and IT systems which did made it difficult for operating managers to get good information about where WM had exposure across its footprint. In late 2006, at a small dinner meeting in Seattle, a WM senior executive who was attending as a guest, opined that WM saw no problem with sub-prime lending as long as housing prices continued to increase at high single digits every year. When pressed by a manager of a small hedge fund as to the potential outcome if housing prices flattened out, or even declined, the exec indicated that their models showed no chance of that happening in the next five years. I ran into that hedgie last month, and he told me he shorted WM right after that dinner. Wish I had done the same. When the housing market peaked, the lack of systems became the fatal flaw, as no one could get reliable information about the enterprise in a timely fashion, creating FUD among shareholders, depositors, and even some high level WM managers I know. The employee stories make one wonder why the company did not collapse even sooner than it did.

  14. Pat O'Brien

    Killinger was the smartest guy in the room at every board meeting. Problem was, he wasn’t very smart. His top managers were the dumbest bunch of flunkies I have ever met at a company as large as WAMU.

  15. Gail

    In the 1980s Composit Income Fund advertised a 13% yield in a 10% market. I worked for Murphey Favour. When the brokers left because unhappy investors inquired about spent returned capital, I was assigned to answer their questions. It appeared to me that company policy was to mislead investors which generated a lot of pain. This was a small part of the company. Twenty years later I suspect they mislead customers in the core business of the bank.

  16. Jim Vanasek

    Tom, you got right to the heart of the issues and were absolutely correct. Regards JGV

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