III. HIGH RISK LENDING:
CASE STUDY OF WASHINGTON MUTUAL BANK
D. Shoddy Lending Practices
At the same time they increased their higher risk lending, WaMu and Long Beach engaged in a host of poor lending practices that produced billions of dollars in poor quality loans. Those practices included offering high risk borrowers large loans; steering borrowers to higher risk loans; accepting loan applications without verifying the borrower's income; using loans with low teaser rates to entice borrowers to take out larger loans; promoting negative amortization loans which led to many borrowers increasing rather than paying down their debt over time; and authorizing loans with multiple layers of risk. WaMu and Long Beach also exercised weak oversight over their loan personnel and third party mortgage brokers, and tolerated the issuance of loans with fraudulent or erroneous borrower information.
Throughout the period reviewed by the Subcommittee, from 2004 until its demise in September 2007, Long Beach was plagued with problems. Long Beach was one of the largest subprime lenders in the United States, |206| but it did not have any of its own loan officers. Long Beach operated exclusively as a "wholesale lender," meaning all of the loans it issued were obtained from third party mortgage brokers who had brought loans to the company to be financed. Long Beach "account executives" solicited and originated the mortgages that were initiated by mortgage brokers working directly with borrowers. Long Beach account executives were paid according to the volume of loans they originated, with little heed paid to loan quality.
Throughout the period reviewed by the Subcommittee, Long Beach's subprime home loans and mortgage backed securities were among the worst performing in the subprime industry. Its loans repeatedly experienced early payment defaults, its securities had among the highest delinquencies in the market, and its unexpected losses and repurchase demands damaged its parent corporation's financial results. Internal documentation from WaMu shows that senior management at the bank was fully aware of Long Beach's shoddy lending practices, but failed to correct them.
2003 Halt in Securitizations. For a brief period in 2003, Long Beach was required by WaMu lawyers to stop all securitizations until significant performance problems were remedied. While the problems were addressed and securitizations later resumed, many of the issues returned and lingered for several years.
The problems with Long Beach's loans and securitizations predated the company's purchase by WaMu in 1999, but continued after the purchase. An internal email at WaMu's primary federal regulator, the Office of Thrift Supervision (OTS), observed the following with respect to Long Beach's mortgage backed securities:
"Performance data for 2003 and 2004 vintages appear to approximate industry average while issues prior to 2003 have horrible performance. LBMC finished in the top 12 worst annualized NCLs [net credit losses] in 1997 and 1999 thru 2003. LBMC nailed down the worst spot at top loser… in 2000 and placed 3rd in 2001." |207|
In 2003, Long Beach's performance deteriorated to the point that WaMu's legal department put a stop to all Long Beach securitizations until the company improved its operations. |208| An internal review of Long Beach's first quarter 2003 lending "concluded that 40% (109 of 271) of loans reviewed were considered unacceptable due to one or more critical errors." |209| According to a 2003 joint report issued by regulators from the FDIC and Washington State: "This raised concerns over LBMC's ability to meet the representations and warranty's made to facilitate sales of loan securitizations, and management halted securitization activity." |210| A Long Beach corporate credit review in August 2003 confirmed that "credit management and portfolio oversight practices were unsatisfactory." |211|
As a result of the halt in securitizations, Long Beach had to hold loans on its warehouse balance sheet, which increased by approximately $1 billion per month and reached nearly $5 billion by the end of November 2003. Long Beach had to borrow money from WaMu and other creditors to finance the surge. |212| The joint visitation report noted that unless Long Beach executed a $3 billion securitization by January 2004, "liquidity will be strained." |213| WaMu initiated a review of Long Beach led by its General Counsel Faye Chapman. |214| Her team evaluated the loans that had accumulated during the halt in securitizations. The joint visitation report noted that of 4,000 Long Beach loans reviewed by WaMu by the end of November 2003, less than one quarter, about 950, could be sold to investors, another 800 were unsaleable, and the rest—over half of the loans—had deficiencies that had to be remediated before a sale could take place. |215|
After a short hiatus, WaMu allowed Long Beach to resume securitizing subprime loans in 2004. |216| An internal WaMu memorandum, later prepared by a WaMu risk officer who had been asked to review Long Beach in 2004, recalled significant problems:
"You've asked for a chronological recap of ERM [Enterprise Risk Management] market risk involvement with Longbeach and the sub prime conduit. … [In] 2004: I conducted an informal but fairly intensive market risk audit of Longbeach …. The climate was very adversarial. … We found a total mess." |217|
A November 2004 email exchange between two WaMu risk officers provides a sense that poor quality loans were still a problem. The first WaMu risk officer wrote:
"Just a heads-up that you may be getting some outreach from Carroll Moseley (or perhaps someone higher up in the chain) at Long Beach regarding their interest in exploring the transfer of … a small amount (maybe $10-20mm in UPB [unpaid principal balance]) of Piggieback ‘seconds' (our favorite toxic combo of low FICO borrower and HLTV loan) from HFS [hold for sale portfolio] to HFI [hold for investment portfolio].
"As Carroll described the situation, these are of such dubious credit quality that they can't possibly be sold for anything close to their ‘value' if we held on to them. … I urged him to reach out to you directly on these questions. (E.g., it's entirely possible we might want to make a business decision to keep a small amount of this crap on our books if it was already written down to near zero, but we would want all parties to be clear that no precedent was being set for the product as a whole, etc., etc.)." |218|
The second risk officer sent the email to the head of Long Beach, with the comment, "I think it would be prudent for us to just sell all of these loans."
2005 Early Payment Defaults. Early in 2005, a number of Long Beach loans experienced "early payment defaults," meaning that the borrower failed to make a payment on the loan within three months of the loan being sold to investors. That a loan would default so soon after origination typically indicates that there was a problem in the underwriting process. Investors who bought EPD loans often demanded that Long Beach repurchase them, invoking the representations and warranties clause in the loan sales agreements.
To analyze what happened, WaMu conducted a "post mortem" review of 213 Long Beach loans that experienced first payment defaults in March, April, and May of 2005. |219| The review found that many early defaults were not only preventable, but that in some instances fraud should have been easily detected from the presence of "White Out" on an application or a borrower having two different signatures:
"First Payment Defaults (FPD's) are preventable and / or detectable in nearly all cases (~99%)[.] Most FPD cases (60%) are failure of current control effectiveness[.] … High incident rate of potential fraud among FPD cases[.] … All roles in the origination process need to sharpen watch for misrepresentation and fraud[.] … Underwriting guidelines are not consistently followed and conditions are not consistently or effectively met[.] … Underwriters are not consistently recognizing non-arm's length transactions and/or underwriting associated risk effectively[.] … Credit Policy does not adequately address certain key risk elements in layered high risk transactions[.] …
"66% of reviewed FPD cases had significant variances in the file[.] … Stated Income should be reviewed more closely ([fraud] incidence rate of 35%) …. Signatures should be checked – 14% Borrowers signature vary[.] Altered documents are usually detectable –5% White-out on documentation[.] … 92% of the Purchases reviewed are 100% CLTV [combined loan-to-value][.] … 52% are Stated Income." |220|
A subsequent review conducted by WaMu's General Auditor of the "root causes" of the Long Beach loans with early payment defaults pointed not only to lax lending standards and a lack of fraud controls, but also to "a push to increase loan volume":
"In 2004, LBMC [Long Beach] relaxed underwriting guidelines and executed loan sales with provisions fundamentally different from previous securitizations. These changes, coupled with breakdowns in manual underwriting processes, were the primary drivers for the increase in repurchase volume. The shift to whole loan sales, including the EPD provision, brought to the surface the impact of relaxed credit guidelines, breakdowns in manual underwriting processes, and inexperienced subprime personnel. These factors, coupled with a push to increase loan volume and the lack of an automated fraud monitoring tool, exacerbated the deterioration in loan quality." |221|
Due to the early payment defaults, Long Beach was forced to repurchase loans totaling nearly $837 million in unpaid principal, and incurred a net loss of about $107 million. |222| This loss overwhelmed Long Beach's repurchase reserves, leading to a reserve shortfall of nearly $75 million. |223| Due to its insufficient loss reserves, its outside auditor, Deloitte and Touche, cited Long Beach for a serious deficiency in its financial reporting. |224| These unexpected repurchases were significant enough that Washington Mutual Inc., Long Beach's parent company, made special mention of them in its 2005 10-K filing:
"In 2004 and 2005, the Company's Long Beach Mortgage Company subsidiary engaged in whole loan sale transactions of originated subprime loans in which it agreed to repurchase from the investor each ‘early payment default' loan at a price equal to the loan's face value plus the amount of any premium paid by the investor. An early payment default occurs when the borrower fails to make the first post-sale payment due on the loan by a contractually specified date. Usually when such an event occurs, the fair value of the loan at the time of its repurchase is lower than the face value. In the fourth quarter of 2005, the Company experienced increased incidents of repurchases of early payment default loans sold by Long Beach Mortgage Company and this trend is expected to continue in the first part of 2006. |225|
In addition to the early payment default problem, a September 2005 WaMu audit observed that at Long Beach, policies designed to mitigate the risk of predatory lending practices were not always followed. The audit report stated: "In 24 of 27 (88%) of the refinance transactions reviewed, policies established to preclude origination of loans providing no net tangible benefit to the borrower were not followed." |226| In addition, in 8 out of 10 of the newly issued refinance loans that WaMu reviewed, Long Beach had not followed procedures designed to detect "loan flipping," an industry term used to describe the practice of unscrupulous brokers or lenders quickly or repeatedly refinancing a borrower's loan to reap fees and profits but provide no benefit to the borrower. |227|
2006 Purchase of Long Beach. In response to all the problems at Long Beach, at the end of 2005, WaMu fired Long Beach's senior management and moved the company under the direct supervision of the President of WaMu's Home Loans Division, David Schneider. |228| Washington Mutual promised its regulator, OTS, that Long Beach would improve. |229| The bank also filed a formal application, requiring OTS approval, to purchase Long Beach from its parent company, so that it would become a wholly owned subsidiary of the bank. |230| WaMu told OTS that making Long Beach a subsidiary would give the bank greater control over Long Beach's operations and allow it to strengthen Long Beach's lending practices and risk management, as well as reduce funding costs and administrative expenses. |231| In addition, WaMu proposed that it replace its current "Specialty Mortgage Finance" program, which involved purchasing subprime loans for its portfolio primarily from Ameriquest, with a similar loan portfolio provided by Long Beach. |232| OTS had expressed a number of concerns about Long Beach in connection with the purchase request, |233| but in December 2005, after obtaining commitments from WaMu to strengthen Long Beach's lending and risk management practices, OTS agreed to the purchase. |234| The actual purchase date was March 1, 2006. |235|
Immediately after the purchase in April 2006, after reviewing Long Beach's operations, WaMu President Rotella sent an email to WaMu CEO Killinger warning about the extent of the problems: "[D]elinquencies are up 140% and foreclosures close to 70%. … First payment defaults are way up and the 2005 vintage is way up relative to previous years. It is ugly." |236| Mr. Rotella, however, expressed hope that operations would improve:
"Early changes by the new team from HL [Home Loans], who have deep subprime experience, indicate a solid opportunity to mitigate some of this. I would expect to see this emerge in 3 to 6 months. That said, much of the paper we originated in the 05 growth spurt was low quality. … I have the utmost confidence in the team overseeing this now and no doubt this unit will be more productive and better controlled, but I figured you should know this is not a pretty picture right now. We are all over it, but as we saw with repurchases, there was a lot of junk coming in."
Despite the new management and direct oversight by WaMu's Home Loans Division, Long Beach continued to perform poorly. Five months later, expected improvements had not materialized. In September 2006, Mr. Rotella sent another email to Mr. Killinger stating that Long Beach was still "terrible":
"[Long Beach] is terrible, in fact negative right now. … We are being killed by the lingering movement of EPDs [early payment defaults] and other credit related issues …. [W]e are cleaning up a mess. Repurchases, EPDs, manual underwriting, very weak servicing/collections practices and a weak staff. Other than that, well you get the picture." |237|
Again, he expressed hope that the situation would improve: "The good news is David and his team are pros and are all over it." |238| Two months later, in November 2006, however, the head of WaMu Capital Markets in New York, David Beck, relayed even more bad news to Mr. Schneider, the Home Loans President: "LBMC [Long Beach] paper is among the worst performing in the mkt [market] in 2006." |239|
Despite the additional focus on improving its lending operations throughout 2006, Long Beach was once again flooded with repurchase requests. According to a memorandum later written by an FDIC examination specialist, "[d]uring 2006, more than 5,200 LBMC loans were repurchased, totaling $875.3 million." |240| Even though, in January 2006, the bank had ceased executing whole loan sales which allowed an automatic repurchase in the event of an EPD, 46% of the repurchase volume was as a result of EPDs. Further, 43% of the repurchase volume resulted from first payment defaults (FPDs) in which the borrower missed making the first payment on the loan after it was sold. |241| Another 10% of the repurchases resulted from violations related to representation and warranties (R&W) not included in the EPD or FPD numbers, meaning the violations were identified only later in the life of the loan.
R&W repurchases generally pose a challenge for a bank's loss reserves, because the potential liability—the repurchase request—continues for the life of the loan. The FDIC memorandum observed:
"Management claims that R&W provisions are industry standard and indeed they may be. However, I still found that the Mortgage Loan Purchase Agreement contains some representations and warranties worth noting. For example, not only must the loans be ‘underwritten in accordance with the seller's underwriting guideline,' but the ‘origination, underwriting, and collection practices used by the seller with respect to each mortgage loan have been in all material respects legal, proper, prudent, and customary in the subprime mortgage business.' This provision elevates the potential that investors can put back a problem loan years after origination and not only must the loan have been underwritten in line with bank guidelines but must also have been underwritten in accordance with what is customary with other subprime lenders." |242|
R&W repurchase requests and loss reserves continued to be an issue at Long Beach. The fourth quarter of 2006 saw another spike in R&W repurchase requests, and in December the required amount of R&W loss reserves jumped from $18 million to $76 million. |243|
On December 22, 2006, the FDIC Dedicated Examiner at WaMu, Steve Funaro, sent an email to Mr. Schneider, the Home Loans President, raising questions about the unexpected loan defaults and repurchase demands. He wrote that Long Beach had the "[s]ame issues as FPD last quarter … Current forecast of 35 to 50m [million] risk." His email also noted potentially insufficient loss reserves related to WaMu's own subprime conduit that purchased subprime loans from other lenders and mortgage brokers, some of which were going out of business and would be unable to shoulder any liability for defaulting loans. His email noted forecasts of early payment defaults totaling $15.6 million and loan delinquencies totaling $10.7 million, in addition to other problems, and asked: "Why the miss? … Who is accountable?" |244|
Mr. Schneider forwarded the email to his team and expressed frustration at Long Beach's continuing problems:
"Short story is this is not good. … There is [a] growing potential issue around Long Beach repurchases …. [W]e have a large potential risk from what appears to be a recent increase in repurchase requests. … We are all rapidly losing credibility as a management team." |245|
Performance in 2007 Worsens. The following year, 2007, was no better as the performance of WaMu's loan portfolio continued to deteriorate. WaMu's chief risk officer, Ron Cathcart, asked WaMu's Corporate Credit Review team to assess the quality of Long Beach loans and RMBS securities in light of the slowdown and decline in home prices in some areas. |246| In January 2007, he forwarded an email with the results of the review, which identified "key risk issues" related to recent loans and described deteriorating loan performance at Long Beach. The "top five priority issues" were:
"Appraisal deficiencies that could impact value and were not addressed[;]
Material misrepresentations relating to credit evaluation were confirmed[;]
Legal documents were missing or contained errors or discrepancies[;]
Credit evaluation or loan decision errors[; and]
Required credit documentation was insufficient or missing from the file." |247|
The review also found: "[D]eterioration was accelerating in recent vintages with each vintage since 2002 having performed worse than the prior vintage." Mr. Cathcart also expressed concern that problems were not being reported to senior management. He wrote: "Long Beach represents a real problem for WaMu. … I am concerned that Credit Review may seem to have been standing on the sidelines while problems continue. For instance, why have Cathcart, Schneider, Rotella and Killinger received NO report on any of this?" |248|
In February 2007, WaMu senior managers discussed "how best to dispose" of $433 million in Long Beach performing second lien loans, due to "disarray" in the securitization market. |249| David Beck, head of WaMu's Wall Street operation, wrote that securitizing the loans was "not a viable exit strategy" and noted:
"Investors are suffering greater than expected losses from subprime in general as well as subprime 2nd lien transactions. As you know, they are challenging our underwriting representations and warrants. Long Beach was able to securitize 2nd liens once in 2006 in May. We sold the BBB- bonds to investors at Libor +260. To date, that transaction has already experienced 7% foreclosures." |250|
WaMu CEO Killinger complained privately to President Steve Rotella:
"Is this basically saying that we are going to lose 15 [percent] on over $400 million of this product or 60 million. That is a pretty bad hit that reflects poorly on credit and others responsibility for buying this stuff. Is this showing up in hits to compensation or personnel changes." |251|
WaMu President Rotella responded:
"This is second lien product originated 7-10 months ago from Long Beach. … In 2006 Beck's team started sprinkling seconds in deals as they could. And, we now have the % down to the low single digits, so that we can sell all into our deals (assuming the market doesn't get even worse)."
He continued: "In terms of folks losing their jobs, the people largely responsible for bringing us this stuff are gone, the senior management of LB." |252|
Also in February 2007, early payment defaults again ticked up. A review of the first quarter of 2007 found: "First payment defaults (FPDs) rose to 1.96% in March but are projected to fall back to 1.87% in April based on payments received through May 5th." |253| It also reported that the findings from a "deep dive into February FPDs revealed" that many of the problems could have been eliminated had existing guidelines been followed:
"The root cause of over 70% of FPDs involved operational issues such as missed fraud flags, underwriting errors, and condition clearing errors. This finding indicates there may be opportunities to improve performance without further restricting underwriting guidelines." |254|
In June 2007, WaMu decided to discontinue Long Beach as a separate entity, and instead placed its subprime lending operations in a new WaMu division called "Wholesale Specialty Lending." That division continued to purchase subprime loans and issue subprime securitizations.
Some months later, an internal WaMu review assessed "the effectiveness of the action plans developed and implemented by Home Loans to address" the first payment default problem in the Wholesale Specialty Lending division. |255| After reviewing 187 FPD loans from November 2006 through March 2007, the review found:
"The overall system of credit risk management activities and process has major weaknesses resulting in unacceptable level of credit risk. Exposure is considerable and immediate corrective action is essential in order to limit or avoid considerable losses, reputation damage, or financial statement errors." |256|
In particular, the review found:
"Ineffectiveness of fraud detection tools – 132 of the 187 (71%) files were reviewed … for fraud. [The review] confirmed fraud on 115 [and 17 were] … ‘highly suspect'. ... Credit weakness and underwriting deficiencies is a repeat finding …. 80 of the 112 (71%) stated income loans were identified for lack of reasonableness of income[.] 133 (71%) had credit evaluation or loan decision errors …. 58 (31%) had appraisal discrepancies or issues that raised concerns that the value was not supported." |257|
July 2007 was a critical moment not only for WaMu, but also for the broader market for mortgage securities. In that month, Moody's and S&P downgraded the ratings of hundreds of RMBS and CDO securities, including 40 Long Beach subprime securities. |258| The mass downgrades caused many investors to immediately stop buying subprime RMBS securities, and the securities plummeted in value. Wall Street firms were increasingly unable to find investors for new subprime RMBS securitizations.
In August 2007, WaMu's internal audit department released a lengthy audit report criticizing Long Beach's poor loan origination and underwriting practices. |259| By that time, Long Beach had been rebranded as WaMu's Wholesale Specialty Lending division, the subprime market had collapsed, and subprime loans were no longer marketable. The audit report nevertheless provided a detailed and negative review of its operations:
"[T]he overall system of risk management and internal controls has deficiencies related to multiple, critical origination and underwriting processes .… These deficiencies require immediate effective corrective action to limit continued exposure to losses. … Repeat Issue – Underwriting guidelines established to mitigate the risk of unsound underwriting decisions are not always followed …. Improvements in controls designed to ensure adherence to Exception Oversight Policy and Procedures is required …. [A]ccurate reporting and tracking of exceptions to policy does not exist." |260|
In response, Mr. Rotella wrote to WaMu's General Auditor: "This seems to me to be the ultimate in bayonetting the wounded, if not the dead." |261|
Subprime Lending Ends. In September 2007, with investors no longer interested in buying subprime loans or securitizations, WaMu shut down all of its subprime operations. |262| During the prior year, which was their peak, Long Beach and WaMu had securitized $29 billion in subprime loans; by 2007, due to the collapse of the subprime secondary market, WaMu's volume for the year dropped to $5.5 billion. Altogether, from 2000 to 2007, Long Beach and WaMu had securitized at least $77 billion in subprime loans. |263|
When asked about Long Beach at the Subcommittee's hearing, all of the WaMu former managers who testified remembered its operations as being problematic, and could not explain why WaMu failed to strengthen its operations. Mr. Vanasek, former Chief Risk Officer, testified that Long Beach did not have an effective risk management regime when he arrived at WaMu in 1999, and that it had not developed an effective risk management regime by the time he retired at the end of 2005. |264| Likewise, Mr. Cathcart, who replaced Mr. Vanasek as Chief Risk Officer, testified that Long Beach never developed effective risk management during the course of his tenure. |265|
At the April 13 Subcommittee hearing, Senator Levin asked Mr. Vanasek: "Is it fair to say that WaMu is not particularly worried about the risk associated with Long Beach subprime mortgages because it sold those loans and passed the risk on to investors?" Mr. Vanasek replied: "Yes, I would say that was a fair characterization." |266|
Home Loans President David Schneider, who had direct responsibility for addressing the problems at Long Beach, testified that he tried to improve Long Beach, but "ultimately decided … Long Beach was an operation that we should shut down." |267| WaMu President Steve Rotella also acknowledged the inability of WaMu management to resolve the problems at Long Beach:
"We did bring the volume in Long Beach down substantially every quarter starting in the first quarter of 2006. As we went through that process, it became increasingly clear, as I have indicated in here, that the problems in Long Beach were deep and the only way we could address those were to continue to cut back volume and ultimately shut it down." |268|
Community Impact. Long Beach's poor quality loans not only proved unprofitable for many investors, they were often devastating for the borrowers and their communities. Mr. Killinger testified at the Subcommittee hearing that WaMu, "entered the subprime business with our purchase of Long Beach Mortgage in 1999 to better serve an underserved market." |269| But the unfortunate result of many Long Beach loans was that they left communities reeling from widespread foreclosures and lost homes.
In November 2008, the Office of the Comptroller of the Currency (OCC) which oversees all nationally chartered banks, identified the ten metropolitan areas across the United States with the highest rates of foreclosure for subprime and Alt A mortgages originated from 2005 through 2007. |270| Those ten areas were, in order: Detroit, Cleveland, Stockton, Sacramento, Riverside/San Bernardino, Memphis, Miami/Fort Lauderdale, Bakersfield, Denver, and Las Vegas. The OCC then identified the lenders with the highest foreclosure rates in each of those devastated cities. Long Beach had the worst foreclosure rate in four of those areas, and was near the worst in five more, with the lone exception being Las Vegas. The OCC data also showed that, overall in the ten metropolitan areas, Long Beach mortgages had the second worst foreclosure rate of all the lenders reviewed, with over 11,700 foreclosures at the time of the report. Only New Century was worse.
Washington Mutual's problems were not confined to its subprime operations; they also affected its retail operations. WaMu loosened underwriting standards as part of its High Risk Lending Strategy, and received repeated criticisms from its regulators, as outlined in the next chapter, for weak underwriting standards, risk layering, excessive loan error and exception rates, appraisal problems, and loan fraud. In August of 2007, more than a year before the collapse of the bank, WaMu's President Steve Rotella emailed CEO Kerry Killinger saying that, aside from Long Beach, WaMu's prime home loan business "was the worst managed business I had seen in my career." |271|
One reason for WaMu's poor lending practices was its failure to adequately monitor the hundreds of billions of dollars of residential loans being issued each year by its own loan personnel. From 1990 until 2002, WaMu acquired more than 20 new banks and mortgage companies, including American Savings Bank, Great Western Bank, Fleet Mortgage Corporation, Dime Bancorp, PNC Mortgage, and Long Beach. WaMu struggled to integrate dozens of lending platforms, information technology systems, staffs, and policies, whose inconsistencies and gaps exposed the bank to loan errors and fraud.
To address the problem, WaMu invested millions of dollars in a technology program called Optis, which WaMu President Rotella described in the end as "a complete failure" that the bank "had to write off" and abandon. |272| In 2004, an OTS Report of Examination (ROE), which was given to the bank's Board of Directors, included this observation:
"Our review disclosed that past rapid growth through acquisition and unprecedented mortgage refinance activity placed significant operational strain on [Washington Mutual] during the early part of the review period. Beginning in the second half of 2003, market conditions deteriorated, and the failure of [Washington Mutual] to fully integrate past mortgage banking acquisitions, address operational issues, and realize expectations from certain major IT initiatives exposed the institution's infrastructure weaknesses and began to negatively impact operating results." |273|
The records reviewed by the Subcommittee showed that, from 2004 until its shuttering in 2008, WaMu constantly struggled with information technology issues that limited its ability to monitor loan errors, exception rates, and indicators of loan fraud.
From 2004 to 2008, WaMu's regulators also repeatedly criticized WaMu's failure to exercise sufficient oversight of its loan personnel to reduce excessive loan error and exception rates that allowed the issuance of loans in violation of WaMu's credit standards. |274| In 2004, Craig Chapman, then the President of WaMu Home Loans, visited a number of the bank's loan centers around the country. Lawrence Carter, then OTS Examiner-in-Charge at WaMu, spoke with Mr. Chapman about what he found. Recalling that conversation in a later email, Mr. Carter wrote:
"Craig has been going around the country visiting home lending and fulfillment offices. His view is that band-aids have been used to address past issues and that there is a fundamental absence of process." |275|
The regulators' examination reports on WaMu indicate that its oversight efforts remained weak. In February 2005, OTS stated that WaMu's loan underwriting "has been an area of concern for several exams." |276| In June 2005, OTS expressed concern about the bank's underwriting exceptions and policy compliance. |277| In August of the same year, the OTS Report of Examination stated that, "the level of deficiencies, if left unchecked, could erode the credit quality of the portfolio," and specifically drew attention to WaMu concentrations in higher risk loans that were a direct result of its High Risk Lending Strategy. |278| 2006 was no better. OTS repeatedly criticized the level of underwriting exceptions and errors. |279|
Another problem was the weak role played by WaMu's compliance department. In March 2007, an OTS examiner noted that WaMu had just hired its "ninth compliance leader since 2000," and that its "compliance management program has suffered from a lack of steady, consistent leadership." The examiner added: "The Board of Directors should commission an evaluation of why smart, successful, effective managers can't succeed in this position. … (HINT: It has to do with top management not buying into the importance of compliance and turf warfare and Kerry [Killinger] not liking bad news.)" |280|
Still another problem was that WaMu failed to devote sufficient resources to overseeing the many loans it acquired from third party lenders and mortgage brokers. The 2010 Treasury and FDIC IG report found that, from 2003 to 2007, a substantial portion of WaMu's residential loans—from 48% to 70%—came from third party lenders and brokers. |281| The IG report also found:
"The financial incentive to use wholesale loan channels for production was significant. According to an April 2006 internal presentation to the WaMu Board, it cost WaMu about 66 percent less to close a wholesale loan ($1,809 per loan) than it did to close a retail loan ($5,273). Thus, WaMu was able to reduce its cost of operations through the use of third-party originators but had far less oversight over the quality of originations." |282|
During its last five years, WaMu accepted loans from tens of thousands of third party brokers and lenders across the country, not only through its wholesale and correspondent channels, but also through its securitization conduits that bought Alt A and subprime loans in bulk. Evidence gathered by the Subcommittee from OTS examination reports, WaMu internal documents, and oral testimony shows that WaMu exercised weak oversight over the thousands of brokers submitting loans. For example, a 2003 OTS report concluded that WaMu's "annual review and monitoring process for wholesale mortgage brokers was inadequate, as management did not consider key performance indicators such as delinquency rates and fraud incidents." |283| A 2003 WaMu quality assurance review found an "error rate of 29 percent for wholesale mortgage loans, more than triple the acceptable error rate of 8 percent established by WaMu." |284| A 2004 OTS examination noted that 20,000 brokers and lenders had submitted loans to WaMu for approval during the year, a volume that was "challenging to manage." |285| A 2005 internal WaMu investigation of two high volume loan centers in Southern California that accepted loans from brokers found that "78% of the funded retail broker loans reviewed were found to contain fraud." |286| A 2006 internal WaMu inquiry into why loans purchased through its subprime conduit were experiencing high delinquency rates found the bank had securitized broker loans that were delinquent, not underwritten to standards, and suffering from "lower credit quality." |287|
OTS examinations in 2006 and 2007 also identified deficiencies in WaMu's oversight efforts. |288| For example, a 2007 OTS memorandum found that, in 2007, Washington Mutual had only 14 full-time employees overseeing more than 34,000 third party brokers submitting loans to the bank for approval, |289| which meant that each WaMu employee oversaw more than 2,400 brokers. The OTS examination not only questioned the staffing level, but also criticized the scorecard WaMu used to rate the mortgage brokers, which did not include the rates at which significant lending or documentation deficiencies were attributed to the broker, the rate at which the broker's loans were denied or produced unsaleable loans, or any indication of whether the broker was included on industry watch lists for prior or suspected misconduct.
In 2006, federal regulators issued Interagency Guidance on Nontraditional Mortgage Product Risks (NTM Guidance) providing standards on how banks "can offer nontraditional mortgage products in a safe and sound manner." |290| It focused, in part, on the need for banks to "have strong systems and controls in place for establishing and maintaining relationships" with third party lenders and brokers submitting high risk loans for approval. It instructed banks to monitor the quality of the submitted loans to detect problems such as "early payment defaults, incomplete documentation, and fraud." If problems arose, the NTM Guidance directed banks to "take immediate action":
"Oversight of third party brokers and correspondents who originate nontraditional mortgage loans should involve monitoring the quality of originations so that they reflect the institution's lending standards and compliance with applicable laws and regulations. … If appraisal, loan documentation, credit problems or consumer complaints are discovered, the institution should take immediate action." |291|
WaMu did, at times, exercise oversight of its third party brokers. A 2006 credit review of its subprime loans, for example, showed that Long Beach—which by then reported to the WaMu Home Loans Division—had terminated relationships with ten brokers in 2006, primarily because their loans had experienced high rates of first payment defaults requiring Long Beach to repurchase them at significant expense. |292| But terminating those ten brokers was not enough to cure the many problems with the third party loans WaMu acquired. The report also noted that, in 2006, apparently for the first time, Long Beach had introduced "collateral and broker risk" into its underwriting process. |293|
WaMu closed down its wholesale and subprime channels in 2007, and its Alt A and subprime securitization conduits in 2008.
During the five-year period reviewed by the Subcommittee, from 2004 to 2008, WaMu issued many loans with multiple higher risk features, a practice known as "risk layering." At the April 13 Subcommittee hearing, Mr. Vanasek, its Chief Risk Officer from 2004 to 2005, testified about the dangers of this practice:
"It was the layering of risk brought about by these incremental changes that so altered the underlying credit quality of mortgage lending which became painfully evident once housing prices peaked and began to decline. Some may characterize the events that took place as a ‘perfect storm,' but I would describe it as an inevitable consequence of consistently adding risk to the portfolio in a period of inflated housing price appreciation." |294|
Stated Income Loans. One common risk layering practice at WaMu was to allow borrowers to "state" the amount of their annual income in their loan applications without any direct documentation or verification by the bank. Data compiled by the Treasury and the FDIC IG report showed that, by the end of 2007, 50% of WaMu's subprime loans, 73% of its Option ARMs, and 90% of its home equity loans were stated income loans. |295| The bank's acceptance of unverified income information came on top of its use of loans with other high risk features, such as borrowers with low credit scores or the use of low initial teaser interest rates followed by much higher rates.
Stated income loans were originally developed to assist self employed individuals that had good credit and high net worth to obtain loans they could afford. But from 2004 to 2008, stated income loans became much more widespread, including with respect to a wide variety of high risk loans. |296| Mr. Cathcart testified at the Subcommittee hearing:
"[Stated income loans] originated as a product for self-employed individuals who didn't have pay stubs and whose financial statements didn't necessarily reflect what they made. It was intended to be available for only the most creditworthy borrowers and it was supposed to be tested for reasonableness so that a person who said that they were a waiter or a lower-paid individual couldn't say that they had an income of $100,000.
"I think that the standards eroded over time. At least I have become aware, reading all that has happened … standards eroded over time and that it became a competitive tool that was used by banks to gather business, so that if a loan consultant could send his loan to Bank A or Bank B, the consultant would say, well, why don't you go to Bank B? You don't have to state your income.
"I do think, thinking it through, that there was a certain amount of coaxing that was possible between the loan consultant and the individual, which would be something which would be invisible to a bank that received the application and the only test for that would be reasonableness, which as you have heard there were some issues within the portfolio." |297|
WaMu required its loan personnel to determine whether a loan applicant's stated income was reasonable, but evidence obtained by the Subcommittee indicates that requirement was not effectively implemented. A 2008 press report about a WaMu stated income loan is illustrative:
"As a supervisor at a Washington Mutual mortgage processing center, John D. Parsons was accustomed to seeing baby sitters claiming salaries worthy of college presidents, and schoolteachers with incomes rivaling stockbrokers. He rarely questioned them. A real estate frenzy was under way and WaMu, as his bank was known, was all about saying yes.
"Yet even by WaMu's relaxed standards, one mortgage four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.
"Mr. Parsons could not verify the singer's income, so he had him photographed in front of his home dressed in his mariachi outfit. The photo went into a WaMu file. Approved." |298|
Instead of verifying borrower income, WaMu loan personnel apparently focused instead on borrower credit scores, as a proxy measure of a borrower's creditworthiness. The problem with this approach, however, was that a person could have a high credit score—reflecting the fact that they paid their bills on time—and still have an income that was insufficient to support the mortgage amount being requested.
High LTV Ratios. A second risk-layering practice at WaMu involved loan-to-value (LTV) ratios. LTV ratios are a critical risk management tool, because they compare the loan amount to the estimated dollar value of the property. If an LTV ratio is too high and the borrower defaults, the sale of the property may not produce sufficient proceeds to pay off the loan. In interagency guidance, federal banking regulators noted that banks should generally avoid issuing loans with LTV ratios over 80%, and directed banks to ensure that loans with LTV ratios of 90% or more have additional credit support such as mortgage insurance or added collateral. |299| The Treasury and the FDIC IG report found that WaMu held a "significant percentage" of home loans in which the LTV ratios exceeded 80%. |300|
These loans were the result of explicit WaMu policies allowing high LTV ratios to be used in loans that already had other high risk features. In February 2005, for example, WaMu set up automated loan approval parameters to approve loans with a 90% LTV in Option ARM and interest-only loans providing financing of up to $1 million. |301| Still another layer of risk was added to these loans by permitting the borrowers to have credit scores as low as 620.
The Treasury and the FDIC IG report determined that 44% of WaMu's subprime loans and 35% of its home equity loans had LTV ratios in excess of 80%. |302| These loans resulted in part from a 2006 WaMu decision to combine home equity loans bearing high LTV ratios with borrowers bearing low credit scores. That initiative was discussed in a June 2006 email sent to Mr. Rotella, after he inquired about the project. He was informed:
"$4 billion home equity investment program [was] approved … last Friday. High CLTVs [Combined Loan-to-Value ratios] (up to 100%) and lower FICOs (down to 600) permitted with some concentration limits." |303|
In order to issue these loans as soon as possible in 2006, WaMu set up an underwriting team to provide "manual" approvals outside of its automated systems:
"Our team is currently focused on several HE [Home Equity] modeling initiatives to include higher risk lending …. [W]e are adjusting our decision engine rules for a July roll out to allow for 580-620 [FICO scores] and LT 80% CLTV [combined loan-to-value] loans to be referred to a manual ‘sub-prime' underwriting team that we are putting in place. … [W]e see this 580-620 segment as the biggest opportunity where we aren't lending today." |304|
Also in 2006, WaMu began issuing so-called "80/20 loans," in which a package of two loans are issued together, imposing an 80% LTV first lien and a 20% LTV second lien on the property, for a total combined LTV (CLTV) of 100%. |305| Loans that provide financing for 100% of a property's value are extremely high risk, because the borrower has no equity in the property, the borrower can stop payments on the loan without losing a personal investment, and a subsequent home sale may not produce sufficient funds to pay off the debt. |306| Yet in 2006, Home Loans Division President David Schneider approved issuing 80/20 loans despite the risk and despite the fact that WaMu's automatic underwriting system was not equipped to accept them, and loan officers initially had to use a manual system to issue the loans. |307|
Using Low Interest Rates to Qualify Borrowers. A third risk layering practice at WaMu was allowing loan officers to qualify prospective borrowers for short term hybrid ARMs or Option ARMs based upon only the initial low rate and not the higher interest rate that would take effect later on. In a filing with the SEC, for example, Washington Mutual Inc. wrote that its "underwriting guidelines" allowed "borrowers with hybrid adjustable-rate home loans … where the initial interest rate is fixed for 2 to 5 years" to be "qualified at the payment associated with the fixed interest rate charged in the initial contractual period." |308| In addition, in 2005, WaMu personnel informed OTS that, since 2004, the bank had not been qualifying its Option ARM borrowers using the "fully indexed rate." |309| Instead, WaMu was using a lower "administrative" rate that was "significantly less than the fully indexed rate." |310|
Borrowers, loan officers, and WaMu executives often assumed that hybrid and Option ARMs could be refinanced before the payments reset to higher levels—an expectation that eventually proved to be unfounded. In a November 30, 2007 email discussing loan modifications from Mr. Schneider to Mr. Killinger, Mr. Rotella and other senior executives, Mr. Schneider described WaMu's faulty assumptions about the "start rate" and life span of these loans:
"I also think it is clear that the economic benefit of providing modifications for these borrowers is compelling for the following reasons:
- None of these borrowers ever expected that they would have to pay at a rate greater than the start rate. In fact, for the most part they were qualified at the start rate
- We need to provide incentive to these borrowers to maintain the home – especially if the home value has declined
- When we booked these loans, we anticipated an average life of 2 years and never really anticipated the rate adjustments…." |311|
Qualifying borrowers using the lower initial interest rate enabled banks to qualify more borrowers for those loans and enabled them to issue loans for larger amounts. Concerned that more banks were beginning to use this risky practice, federal banking regulators addressed it in the October 2006 NTM Guidance, which cautioned banks to use the fully indexed rate when qualifying borrowers for a loan, including loans with lower initial teaser rates. |312| In addition, the Guidance provided that for negatively amortizing loans, banks should consider not only the "initial loan amount" but also "any balance increase that may accrue from the negative amortization provision." |313| After the NTM Guidance was issued, a WaMu analyst calculated that applying the new requirement to all of its loans would cause a 33% drop in its loan volume due to borrowers who would no longer qualify for its loans:
"Implementing the NTM change for Purchase only drops additional 2.5% of volume … If we implement the NTM changes to all loans, then we'll see additional drop of 33% of volume." |314|
In response to this information, WaMu's chief risk officer wrote that the impact on the bank "argues in favor of holding off on implementation until required to act for public relations … or regulatory reasons."
Because OTS gave the bank more than six months to come into compliance with the NTM Guidance, WaMu continued qualifying high risk borrowers using the lower interest rate, originating billions of dollars in new loans that would later suffer significant losses.
WaMu's risk-layering practices went beyond its use of stated income loans, high LTV ratios, and the qualification of borrowers using low initial interest rates. The bank also allowed its loan officers to issue large volumes of high risk loans to borrowers who did not occupy the homes they were purchasing or had large debt-to-income ratios. |315| On top of those risks, WaMu concentrated its loans in a small number of states, especially California and Florida, increasing the risk that a downturn in those states would have a disproportionate impact upon the delinquency rates of its already high risk loans.
At one point in 2004, Mr. Vanasek made a direct appeal to WaMu CEO Killinger, urging him to scale back the high risk lending practices that were beginning to dominate not only WaMu, but the U.S. mortgage market as a whole. Despite his efforts, he received no response:
"As the market deteriorated, in 2004, I went to the Chairman and CEO with a proposal and a very strong personal appeal to publish a full-page ad in the Wall Street Journal disavowing many of the then-current industry underwriting practices, such as 100 percent loan-to-value subprime loans, and thereby adopt what I termed responsible lending practices. I acknowledged that in so doing the company would give up a degree of market share and lose some of the originators to the competition, but I believed that Washington Mutual needed to take an industry-leading position against deteriorating underwriting standards and products that were not in the best interests of the industry, the bank, or the consumers. There was, unfortunately, never any further discussion or response to the recommendation." |316|
Perhaps the clearest evidence of WaMu's shoddy lending practices came when senior management was informed of loans containing fraudulent information, but then did little to stop the fraud.
Downey and Montebello Fraud Investigations. The most significant example involves an internal WaMu investigation that, in 2005, uncovered substantial evidence of loan fraud involving two top producing loan offices in Southern California. WaMu management was presented with the findings, but failed to respond, leading to the same fraud allegations erupting again in 2007. According to the WaMu Home Loans Credit Risk Mitigation Team that conducted the 2005 internal investigation, it was initiated in response to "a sustained history of confirmed fraud findings over the past three years" involving the two offices, known as Downey and Montebello. |317| Each office was located in a low-income area of Los Angeles and headed by a loan officer who had won repeated WaMu awards for high volume loan production.
To conduct its inquiry, the WaMu Risk Mitigation Team reviewed all of the loans produced by the two offices over a two-month period from August to September 2005, which totaled 751 loans. Analysts scored the loans using a standard electronic fraud detection program, and then reviewed all of the loans flagged for possible fraud, as well as ten percent of the remaining loans. |318| A November 2005 memorandum summarizing the review stated that it found an "extensive level of loan fraud" caused primarily by employees circumventing bank policies:
"[A]n extensive level of loan fraud exists in the Emerging Markets [loan processing centers], virtually all of it stemming from employees in these areas circumventing bank policy surrounding loan verification and review. Of the 129 detailed loan review[s] … conducted to date, 42% of the loans reviewed contained suspect activity or fraud, virtually all of it attributable to some sort of employee malfeasance or failure to execute company policy. In terms of employee activity enabling this perpetration of fraud, the following categories of activity appeared most frequently: inconsistent application of credit policy, errors or negligence, process design flaws, intentional circumvention of established processes, and overriding automated decisioning recommendations. … Based on the consistent and pervasive pattern of activity among these employees, we are recommending firm action be taken to address these particular willful behaviors on the part of the employees named." |319|
A presentation prepared for WaMu management provided additional detail. |320| It stated that, out of the 751 loans produced, the Risk Mitigation Team had selected 180 loans for detailed review, of which 129 had been completed. |321| It stated that 42% of the reviewed loans had "contained excessive levels of fraud related to loan qualifying data." |322| It also stated that the fraud findings did not differ between loans originated by WaMu's own loan officers and loans originated by third party brokers and brought to the loan centers. |323| The presentation also stated that the fraud uncovered by the review was found to be "preventable with improved processes and controls."
The presentation indicated that the loan fraud involved primarily "misrepresentation of loan qualifying data," including misrepresentations of income and employment, false credit letters and appraisal issues. |324| The presentation included a few examples of misrepresentations, including:
"Loan #0694256827[:] Misrepresentation [of] the borrower's identification and qualifying information were confirmed in every aspect of this file, including: – Income – SSN – Assets – Alternative credit reference letters – Possible Strawbuyer or Fictitious borrower[.] The credit package was found to be completely fabricated. Throughout the process, red flags were over-looked, process requirements were waived, and exceptions to policy were granted." |325|
The presentation noted that the loan delinquency rate for Luis Fragoso, the loan officer heading the Montebello loan office, was "289% worse than the delinquency performance for the entire open/active retail channel book of business," while the delinquency rate for Thomas Ramirez, the loan officer heading the Downey loan office was 157% worse. |326| The message from the Risk Mitigation Team was clear that the two head loan officers were willfully flouting bank policy, issuing poor quality loans, and needed to be the subject of "firm action" by the bank.
Three months prior to its formal presentation on the fraud, the Risk Mitigation Team supplied a lengthy email with its fraud findings to colleagues in the credit risk department. The August 2005 email provided spreadsheets containing data collected on the loans from the two offices as well as figures about the types of loans reviewed and fraud found. |327| Among other information, it indicated that at the Downey office, 83 loans had been reviewed, including 28 originated by the WaMu loan officer Thomas Ramirez, and 54 submitted to him by third party brokers; while at the Montebello office, 48 loans had been reviewed, including 19 originated by the WaMu loan officer Luis Fragoso and 29 submitted to him by third party brokers. The email was forwarded by a credit risk officer to WaMu's Chief Risk Officer Jim Vanasek, with the following comment:
"As you requested in our Enterprise Fraud Committee meeting last Friday, the attached email contains a high-level summary of the investigations the Home Loans Risk Mit team has conducted on [the two offices] over the past year and a half, based on loans that were referred to them. … As you can see, among the referred cases there is an extremely high incidence of confirmed fraud (58% for Ramirez, 83% for Fragoso) …. [Additional analysis] will allow us to substantially validate what we suspect, which is that the incidence of fraud in this area is greater than with other producers." |328|
At the Subcommittee hearing, Mr. Vanasek agreed these were "eye popping" rates of fraud. |329|
On November 18, 2005, Cheryl Feltgen, the Home Loans Chief Credit Officer, "had a very quick meeting" with Home Loans President David Schneider, the head of Home Loans sales Tony Meola, and others in which she reviewed the memorandum and presentation on the fraud investigation. |330| After the meeting, she sent an email to the Risk Mitigation Team stating: "The good news is that people are taking this very seriously. They requested some additional information that will aid in making some decisions on the right course of action." |331| She asked the Risk Mitigation Team to prepare a new spreadsheet with the loan information, which the team did over the weekend in anticipation of a Monday meeting.
The trail of documentation in 2005 about the fraud investigation ends there. Despite the year-long effort put into the investigation, the written materials prepared, the meetings held, and fraud rates in excess of 58% and 83% at the Downey and Montebello offices, no discernable actions were taken by WaMu management to address the fraud problem in those two offices. No one was fired or disciplined for routinely violating bank policy, no anti-fraud program was installed, no notice of the problem was sent to the bank's regulators, and no investors who purchased RMBS securities containing loans from those offices were alerted to the fraud problem underlying their high delinquency rates. Mr. Vanasek retired from the bank in December 2005, and the new Chief Risk Officer Ron Cathcart was never told about the fraud investigation. Senior personnel, including Mr. Schneider, Mr. Meola, and Ms. Feltgen, failed to follow up on the matter.
Over the next two years, the Downey and Montebello head loan officers, Mr. Ramizez and Mr. Fragoso, continued to issue high volumes of loans |332| and continued to win awards for their loan productivity, including winning trips to Hawaii as members of WaMu's "President's Club." One of the loan officers even suggested to bank President Steve Rotella ways to further relax bank lending standards. |333|
In June 2007, however, the fraud problem erupted again. That month, AIG, which provided mortgage insurance for some of WaMu's residential mortgages, contacted the bank with concerns about material misrepresentations and fraudulent documents included in mortgages being issued by Mr. Fragoso, the loan officer heading the Montebello office. |334| When no one responded to its concerns, in September 2007, AIG filed a Suspected Fraud Claim with the California Department of Insurance which, in turn, notified OTS of the problem. |335| The OTS Examiner-in-Charge at WaMu at the time, Benjamin Franklin, asked the bank to conduct an investigation into the matter. |336| WaMu's legal department asked the WaMu Corporate Fraud Investigation (CFI) group and the Audit department to conduct a joint inquiry.
Seven months later, in April 2008, CFI and the Audit department issued a 12-page memorandum with their findings. |337| The memorandum not only confirmed the presence of fraud in the Montebello office, citing a loan file review that found a fraud rate of 62%, it also uncovered the 2005 investigation that had identified the problem two years earlier, but was ignored by management. The 2008 memorandum stated:
"In 2005, HL [Home Loans] Risk Mitigation provided Senior HL Management with an assessment of fraud and loan performance in the Retail Broker Program and two Southern California Emerging Markets [loan centers] for the period of September 2003 through August 2005. This assessment identified excessive levels of fraud related to loan qualifying data …. It also highlighted the Downey and Montebello [loan centers] as the primary contributors of these fraudulent loan documents based upon volume and articulated strategies to mitigate fraud. The report also stated that delinquency performance on these [loan centers] … were significantly worse that the delinquency performance for the entire open/active retail channel book of business. In 2007, HL Risk Mitigation mirrored their 2005 review with a smaller sample of loans and found that, for the September and October 2007 sampled time period, the volume of misrepresentation and suspected loan fraud continued to be high for this [loan center] (62% of the sampled loans)." |338|
Examples of fraudulent loan information uncovered in the 2007 review included falsified income documents, unreasonable income for the stated profession, false residency claims, inflated appraisal values, failure of the loan to meet bank guidelines, suspect social security numbers, misrepresented assets, and falsified credit information. |339|
The memorandum found that, in 2005, the WaMu Risk Mitigation Team had reported its findings to several WaMu managers whom it "felt were very aware of high volumes of fraud" in the loans issued by the two loan officers. |340| The memorandum reported that one individual
believed that David Schneider "was made aware of these findings" and wanted Risk Mitigation to "monitor the situation." |341| But no one knew "of additional monitoring that was done, or efforts to bring additional attention to" the fraudulent loans from the Downey and Montebello offices. The memorandum also noted that no personnel action had been taken against either of the loan officers heading the two offices. |342| David Schneider was interviewed and "recalled little about the 2005 fraud findings or actions taken to address them." |343| He "thought the matter was handled or resolved." The WaMu memorandum concluded:
"Outside of training sessions … in late 2005, there was little evidence that any of the recommended strategies were followed or that recommendations were operationalized. There were no targeted reviews conducted … on the Downey or Montebello loan portfolios between 2005 and the actions taken in December 2007." |344|
After the memorandum was issued, WaMu initially resisted providing a copy to OTS, claiming it was protected by attorney-client privilege. |345| The OTS Examiner-in-Charge Benjamin Franklin told the Subcommittee that he insisted on seeing the memorandum. After finally receiving it and reading about the substantial loan fraud occurring at the two loan offices since 2005, he told the Subcommittee that it was "the last straw" that ended his confidence that he could rely on WaMu to combat fraudulent practices within its own ranks.
The 2008 WaMu memorandum and a subsequent OTS examination memorandum |346| included a number of recommendations to address the fraud problem at the Downey and Montebello offices. The recommendations in the WaMu memorandum included actions to "[d]etermine appropriate disciplinary actions for employees"; "[e]nhance Code of Conduct training to stress each employee's role as a corporate steward and the consequences for passively facilitating the placement of loans into the origination process that could be suspect"; enhance WaMu compensation incentives "to support loan quality"; and determine if further analysis was required of the loans originated by the Montebello office or "the broader loan population (bank owned and securitized)" including "if actions are needed to address put backs or sales to investors of loans that contain misrepresentation[s] or other fraud findings." |347|
By the time WaMu issued the April 2008 memorandum on the Downey and Montebello fraud problem, however, the bank was already experiencing serious liquidity problems and was cutting back on its loan operations and personnel. On April 30, 2008, WaMu put an end to its wholesale loan channel which had accepted loans from third party mortgage brokers, closed 186 stand-alone loan centers, and reduced its workforce by 3,000. |348| The Downey and Montebello offices were closed as part of that larger effort. The two loan officers heading those offices left the bank and found other jobs in the mortgage industry that involve making loans to borrowers.
Other Fraud Problems. The loan fraud problems at the Downey and Montebello offices were not the only fraud problems plaguing WaMu. The Subcommittee uncovered three additional examples that demonstrate the problem was not isolated.
The first example involves the Westlake Village loan office outside of Los Angeles. On April 1, 2008, WaMu's Risk Mitigation Team sent thirteen home loans with early payment defaults to the WaMu Corporate Fraud Investigations (CFI) group for further examination. |349| All thirteen, whose unpaid loan balances totaled about $14.3 million, had been issued in 2007, by the Westlake Village loan office which was one of WaMu's top loan producers. Two loan officers, Chris O'Brien and Brian Minkow, who worked in tandem, had won multiple awards for their loan production and had a team of 14 sales associates assisting them. |350| CFI reviewed the referred loans which contained a variety of fraud indicators, including "fabricated asset statements, altered statements, income misrepresentation and one altered statement that is believed to have been used in two separate loans." |351| CFI then interviewed the loan officers, sales associates, and personnel at the WaMu "loan fulfillment center" (LFC) that processed Westlake Village loan applications.
In one egregious example of document "manufacturing," a sales associate confessed that if "it was too late to call the borrower," the "sales associates would take [bank] statements from other [loan] files and cut and paste the current borrower's name and address" onto the old bank statements. |352| The same sales associate "admitted that during that crunch time some of the Associates would ‘manufacture' asset statements from previous loan docs," because end-ofmonth loans would often get funded without full documentation. The pressure to get the necessary documentation was "tremendous" and they had been told to get the loans funded "with whatever it took." |353|
The LFC loan processor in charge of handling Westlake Village's loan applications was fired, as was the sales associate who confessed to manufacturing false documents. The rest of the employees were also let go, when the office itself was closed on April 30, 2008, in connection with WaMu's reorganization and downsizing. One of the loan officers who headed the office told the Subcommittee, however, that he had been offered another job within the bank, but declined it due to lower compensation. |354| He went on to work in the mortgage industry arranging residential loans.
The second example involves 25 Home Equity Lines of Credit (HELOCs) totaling $8.5 million that were originated in 2008 by a WaMu loan officer at the Sunnyvale loan office in California. Before all of the loans were funded, they were referred to the Risk Mitigation Team because of fraud indicators. On May 1, 2008, the loan files were sent on to the CFI group for further inquiry. An internal document summarizing the CFI investigation stated:
"The review found that the borrowers indicated they owned the property free and clear when in fact existing liens were noted on the properties. The properties are located in California, Arizona and Washington. … WaMu used … Abbreviated Title reports [that] … do not provide existing lien information on the subject property." |355|
Of the 25 loan applications, 22 were ultimately terminated or declined. The employee involved in originating the loans was terminated as part of the April 30, 2008 reorganization.
The third example involves a review of 2006 and 2007 WaMu loans conducted by Radian Guaranty Inc., a company which provided mortgage insurance for those loans. |356| Radian's objectives were to test WaMu's "compliance with Radian's underwriting guidelines and eligible loan criteria," assess the quality of WaMu's underwriting decisions, "rate the risk of the individual loans insured," and identify any errors in the loan data transmitted to Radian. |357| The review looked at a random selection of 133 loans and found enough problems to give WaMu an overall rating of "unacceptable." |358|
The Radian review identified a number of problems in the loan files it deemed ineligible for insurance. In one, WaMu issued a $484,500 loan to a "Sign Designer" who claimed to be making $34,000 in income every month. |359| The Radian review observed: "Borrower's stated monthly income of $34,000 does not appear reasonable for a ‘Sign Designer.'" The review also noted several high risk elements in the loan, which was an 85% LTV loan given to a borrower with a 689 credit score who used the loan to refinance an existing loan and "cash-out" the equity in the house. The review noted that the borrower received $203,000 at the loan closing. In addition, the review stated that WaMu had appraised the house at $575,000, but an automated appraisal verification program assigned the house a probable value of only $321,000, less than the amount of the loan.
Extent of Fraud. At the Subcommittee hearing, when asked about these matters, Mr. Vanasek, WaMu's Chief Risk Officer from 2004 to 2005, attributed the loan fraud to compensation incentives that rewarded loan personnel and mortgage brokers according to the volume of loans they processed rather than the quality of the loans they produced:
"Because of the compensation systems rewarding volume versus quality and the independent structure of the originators, I am confident at times borrowers were coached to fill out applications with overstated incomes or net worth to meet the minimum underwriting requirements. Catching this kind of fraud was difficult at best and required the support of line management. Not surprisingly, loan originators constantly threatened to quit and to go to Countrywide or elsewhere if the loan applications were not approved." |360|
When asked by Senator Coburn if he thought the type of fraud at the Downey and Montebello loan offices extended beyond those two offices, Mr. Vanasek replied: "Yes, Senator." |361|
Another sobering internal WaMu report, issued in September 2008, a few weeks before the bank's failure, found that loans marked as containing fraudulent information had nevertheless been securitized and sold to investors. The report blamed ineffective controls that had "existed for some time":
"The controls that are intended to prevent the sale of loans that have been confirmed by Risk Mitigation to contain misrepresentations or fraud are not currently effective. There is not a systematic process to prevent a loan in the Risk Mitigation Inventory and/or confirmed to contain suspicious activity from being sold to an investor. ... Of the 25 loans tested, 11 reflected a sale date after the completion of the investigation which confirmed fraud. There is evidence that this control weakness has existed for some time." |362|
Loans not meeting the bank's credit standards, deliberate risk layering, sales associates manufacturing documents, offices issuing loans in which 58%, 62%, or 83% contained evidence of loan fraud, and selling fraudulent loans to investors are evidence of deep seated problems that existed within WaMu's lending practices. Equally disturbing is evidence that when WaMu senior managers were confronted with evidence of substantial loan fraud, they failed to take corrective action. WaMu's failure to strengthen its lending practices, even when problems were identified, is emblematic of how lenders and mortgage brokers produced billions of dollars in high risk, poor quality home loans that contributed to the financial crisis.
In addition to subprime loans, Washington Mutual made a variety of high risk loans to "prime" borrowers, including its flagship product, the Option Adjustable Rate Mortgage ("Option ARM"). Washington Mutual's Option ARMs typically offered borrowers an initial teaser rate, sometimes as low as 1% for the first month, which later adjusted to a much higher floating interest rate linked to an index, but gave borrowers the choice each month of paying a higher or lower amount. These loans were called "Option" ARMs, because borrowers were typically given four options: (1) paying the fully amortizing amount needed to pay off the loan in 30 years; (2) paying an even higher amount to pay off the loan in 15 years; (3) paying only the interest owed that month and no principal; or (4) making a "minimum payment" that covered only a portion of the interest owed and none of the principal. |363| If the borrower selected the minimum payment option, unpaid interest would be added to the loan principal. If the borrower repeatedly selected the minimum payment, the loan principal would increase rather than decrease over time, creating a negatively amortizing loan.
Negative amortization created additional credit risk for WaMu and posed a challenge to risk managers. At the April 13 Subcommittee hearing, Mr. Vanasek testified:
"We had concerns from the standpoint of negative amortization that was accumulating and we had been reassured that in the past, borrowers would negatively amortize during difficult times and then make up for the lost payments in good times. But the percentage and the potential percentage for negative amortization was very large, and, of course the attendant payment shock was also very large, which was a concern to credit." |364|
Few executives at WaMu shared Mr. Vansek's concern about the Option ARM. To the extent that risk managers expressed concern, it was outweighed by the product's favorable gain-onsale margin.
As part of its High Risk Lending Strategy, WaMu determined to increase its issuance of its Option ARM loans. To do that, WaMu had to convince customers to forego a simple, low risk conventional loan in favor of the complex and higher risk Option ARM. In late 2003, WaMu conducted two focus group studies to "explore ways to increase sales of Option ARMs, Washington Mutual's most profitable mortgage loan products." |365| The first focus group examined the views of WaMu loan consultants and third party mortgage brokers. The second focus group examined the views of WaMu Option ARM customers.
The report following the first focus group with WaMu loan consultants and mortgage brokers identified a number of impediments to selling Option ARMs. It noted that Option ARM loans had to be "sold" to customers asking for a 30-year fixed loan, and training was needed to overcome the feeling of "many" WaMu loan consultants that Option ARMs were "bad" for their customers. The report also recommended increasing commissions so salespersons would take the "hour" needed to sell an Option ARM, and increasing loan processing times so salespersons and brokers were not inconvenienced. The report stated in part:
"Option ARMs are sold to customers and few walk through the door and ask for them. ...
If salespeople don't understand Option ARMs, they won't sell them. Many felt that more training would be needed to better educate salespeople about this type of loan, and to change the mindset of current Loan Consultants. Some felt there were many within Washington Mutual who simply felt these loans were ‘bad' for customers, probably from a lack of understanding the product and how it could benefit customers. ...
It is critical that salespeople fully understand a customer's financial situation and motivation for the loan. By taking into account these factors, they can recommend the loan that will best fit their customers' needs. Given today's low interest rate environment, it can be challenging to get salespeople to take the time to do this. Currently it is easier to give customers what they ask for (a 30 year fixed loan) than to sell them an Option ARM. They can take 20 minutes and sell a 30 fixed-rate loan, or spend an hour trying to sell an Option ARM.
Commission caps make it unappealing for Mortgage Brokers to sell Washington Mutual Option ARMs. Most would not sell loans to customers with prepayment penalties, and given the low commission rate for selling them without the prepayment penalty, many simply go to another company or product where they can make more money.
Slow ARM processing times (up to 90 days) can cause Mortgage Brokers to take business elsewhere…
Improving collateral would help salespeople better explain Option ARMs to customers and take away some of the mystery. … They also would like improved brochures which talk to the customer in simple, easy to understand terms about features and benefits. They liked the current sample statements they are provided." |366|
The second focus group with existing Option ARM customers showed they were also unenthusiastic about the product. The focus group report stated:
"In general, people do not seem to have a good understanding of their mortgage and its terms. What understanding they do have is framed by the concept of a 30-year fixed mortgage. Option ARMs are very complicated and need to be explained in simple, easy to understand terms, prospective borrowers need to be educated about the loan – this is not a product that sells itself." |367|
The focus group identified several reasons that borrowers were leery of Option ARMs and suggested ways to address the unease: "Helping prospective borrowers understand payment and interest rate caps may mitigate fears of wild monthly payment swings .… Similarly, fears about negative amortization, a concept also not very well understood by the participants, could be reduced or eliminated by showing how much residential properties in the local market have appreciated over time." |368|
The main findings of the focus group included:
"Few participants fully understood the Option ARM and its key benefits. A number of them were not familiar with the payment options or how they could be used. … Additionally, most did not understand how their interest rate was derived, how often their payments would change, and what, if any, were the interest and/or payment caps.
"Perhaps the best selling point for the Option ARM loan was being shown how much lower their monthly payment would be by choosing an Option ARM versus a fixed-rate loan.
"Many participants did not know what happened to their loan at the end of the fixed interest rate period. Most of them assumed they would have to sell or refinance because of a potential balloon payment or a steep jump in their payments. Because of these misperceptions, most participants expect to refinance their loans within the next three to five years." |369|
To increase Option ARM sales, WaMu increased the compensation paid to its loan personnel and outside mortgage brokers for the loans. |370| The bank also qualified borrowers for Option ARMs by using a monthly payment amount that was less than what the borrower would likely pay once the loan recast. |371|
The Option ARM was also frequently featured in sales promotion efforts communicated to loan officers through WaMu's internal alert email system known as, "e-Flash." For example, a June 5, 2006 e-Flash from Steve Stein, the Director of Retail Lending in the Home Loans division, to the entire retail sales team announced:
"We are beginning to focus on higher-margin products like our flagship product, the Option ARM. This is a fantastic product for almost any borrower. To help our sales force feel more comfortable with selling the Option ARM to a wide variety of borrowers, we are rolling out a comprehensive skills assessment and training initiative. ... This initiative is not about selling the Option ARM to everyone. We will always stay true to our values and provide the right loan for every customer. … Through the skills assessment, training, role playing and a best-practices selling tips video, I think this retail sales team will be unstoppable with the Option ARM. … The Option ARM is our product and we can sell it better than anyone. I have great confidence that we'll improve our Option ARM market share quickly, like the experts that we are." |372|
One month later, Mr. Stein announced increased compensation incentives for selling Option ARMs. In another e-Flash to the entire retail sales team, Mr. Stein wrote:
"You've seen and heard a lot recently about our refined business model and focus on higher margin products, especially Option ARMs. To further drive this focus, I'm pleased to announce the 2006 Option ARM Blitz – Quarterly Incentive Campaign. This will allow eligible Loan Consultants to earn 5 additional basis points on all Option ARM volume funded during the 3rd quarter 2006." |373|
Under the rules of the Option ARM Blitz, loan consultants who increased the percentage of Option ARMs they sold by at least 10% would receive an additional bonus. In August 2006, an e-Flash announced that the underwriting guidelines for Option ARMs had been loosened, allowing higher loan amounts for "condos and co-ops" and greater loan-to-value ratios for "lowdoc" second home mortgages. |374| Also in August, an e-Flash announced that the "Option ARM Sales Mastery Program" that was launched in June, would now become part of the mandatory loan originator training curricula. |375|
In September 2006, WaMu introduced pricing incentives for Option ARMs in the consumer direct channel which waived all closing costs for Option ARMs except for an appraisal deposit. |376| In the fourth quarter of 2006, the consumer direct channel also held a contest called the "Fall Kickoff Contest." For each of the 13 weeks in the quarter, the loan consultant who scored the most points would receive a $100 gift card. An Option ARM sale was a "touchdown" and worth seven points; jumbo-fixed, equity, and nonprime mortgages were only "field goals" worth three points. At the end of the quarter the top five point winners were awarded with a $1,000 gift card. |377| In addition, from November 2006 through January 2007, e-Flashes sent to consumer direct originators promoted Option ARM sales specials offering $1,000 off closing costs for loans under $300,000 and a waiver of all fees for loans greater than $300,000. |378|
Judging by sales of Option ARMs in 2004, after the completion of the focus groups, WaMu's strategy to push sales of Option ARM loans was successful. In 2003, WaMu originated $30.1 billion in Option ARMs; in 2004 WaMu more than doubled its Option ARM originations to $67.5 billion. Although sales of Option ARMs declined thereafter because of challenges in the market, in 2006, WaMu still originated $42.6 billion in Option ARMs. According to its internal documents, by 2006, Washington Mutual was the second largest Option ARM originator in the country. |379|
As WaMu's Option ARM portfolio grew, and as the wider economy worsened, the prevalence of negative amortization in the Option ARMs increased. While WaMu risk managers viewed negative amortization as a liability, WaMu accountants, following generally accepted accounting practices, treated negative amortization as an asset. In 2003, WaMu recognized $7 million in earnings from deferred interest due to negative amortization. |380| By 2006, capitalized interest recognized in earnings that resulted from negative amortization surpassed $1 billion; by 2007 it exceeded $1.4 billion. |381| In other words, as WaMu customers stopped paying down their mortgages, WaMu booked billions of dollars in earnings from the increasing unpaid balances. By another measure, in 2003, $959 million in Option ARM loans that WaMu held in its investment portfolio experienced negative amortization; in 2007, the figure was more than $48 billion. |382|
According to data compiled by the Treasury and the FDIC Inspectors General, in 2005, WaMu borrowers selected the minimum monthly payment option for 56% of the value of the Option ARM loans in its investment portfolio. By the end of 2007, 84% of the total value of the Option ARMs in WaMu's investment portfolio was negatively amortizing. |383| To avoid having their loans recast at a higher interest rate, Option ARM borrowers typically refinanced the outstanding loan balance. Some borrowers chose to refinance every year or two. |384| The Treasury and the FDIC IG report determined that a significant portion of Washington Mutual's Option ARM business consisted of refinancing existing loans. |385|
One WaMu loan officer, Brian Minkow, told the Subcommittee that he expected the vast majority of Option ARMs borrowers to sell or refinance their homes before their payments increased. |386| As long as home prices were appreciating, most borrowers were able to refinance if they chose to. According to Mr. Minkow, who was one of WaMu's top loan consultants and in some years originated more than $1 billion in loans, 80% of his business was in Option ARMs, and 70% of his business consisted of refinances. |387| Once housing prices stopped rising, however, refinancing became difficult. At recast, many people found themselves in homes they could not afford, and began defaulting in record numbers.
WaMu was one of the largest originators of Option ARMs in the country. In 2006 alone, WaMu securitized or sold $115 billion in Option ARMs. |388| Like Long Beach securitizations, WaMu Option ARM securitizations performed badly starting in 2006, with loan delinquency rates between 30 and 50%, and rising. |389|
WaMu knowingly implemented a High Risk Lending Strategy, but failed to establish a corresponding system for risk management. Instead, it marginalized risk managers who warned about and attempted to limit the risk associated with the high risk strategy.
At the time it formally adopted its High Risk Lending Strategy, WaMu executives acknowledged the importance of managing the risks it created. For example, the January 2005 "Higher Risk Lending Strategy ‘Asset Allocation Initiative'" presentation to the Board of Directors Finance Committee stated in its overview:
"In order to generate more sustainable, consistent, higher margins within Washington Mutual, the 2005 Strategic Plan calls for a shift in our mix of business, increasing our Credit Risk tolerance while continuing to mitigate our Market and Operational Risk positions.
"The Corporate Credit Risk Management Department has been tasked, in conjunction with the Business Units, to develop a framework for the execution of this strategy. Our numerous activities include:
-Selecting best available credit loss models
-Developing analytical framework foundation
-Identifying key strategy components per Regulatory Guidance documents
"A strong governance process will be important as peak loss rates associated with this higher risk lending strategy will occur with a several year lag and the correlation between high risk loan products is important. For these reasons, the Credit Department will pro-actively review and manage the implementation of the Strategic Plan and provide quarterly feedback and recommendations to the Executive Committee and timely reporting to the Board." |390|
The robust risk management system contemplated by in the January 2005 memorandum, which was critical to the success of the High Risk Lending Strategy, was never meaningfully implemented. To the contrary, risk managers were marginalized, undermined, and often ignored. As former Chief Risk Manager Jim Vanasek testified at the April 13 Subcommittee hearing:
"I made repeated efforts to cap the percentage of high-risk and subprime loans in the portfolio. Similarly, I put a moratorium on non-owner-occupied loans when the percentage of these assets grew excessively due to speculation in the housing market. I attempted to limit the number of stated income loans, loans made without verification of income. But without solid executive management support, it was questionable how effective any of these efforts proved to be." |391|
Later in the hearing, Mr. Vanasek had the following exchange with Senator Coburn:
Senator Coburn: Did you ever step in and try to get people to take a more conservative approach at WaMu?
Mr. Vanasek: Constantly.
Senator Coburn: Were you listened to?
Mr. Vanasek: Very seldom.
Senator Coburn: [Had] you ever felt that your opinions were unwelcomed, and could you be specific?
Mr. Vanasek: Yes. I used to use a phrase. It was a bit of humor or attempted humor. I used to say the world was a very dark and ugly place in reference to subprime loans. I cautioned about subprime loans consistently. |392|
Mr. Vanasek's description of his efforts is supported by contemporaneous internal documents. In a February 24, 2005 memorandum to the Executive Committee with the subject heading, "Critical Pending Decisions," for example, Mr. Vanasek cautioned against expanding WaMu's "risk appetite":
"My credit team and I fear that we are considering expanding our risk appetite at exactly the wrong point and potentially walking straight into a regulatory challenge and criticism from both the Street and the Board. Said another way I fear that the timing of further expansion into higher risk lending beyond what was contemplated in the '05 Plan and most especially certain new products being considered is ill-timed given the overheated market and the risk [of] higher interest rates….
So we come down to the basic question, is this the time to expand beyond the '05 Plan and/or to expand into new categories of higher risk assets? For my part I think not. We still need to complete EDE [Enterprise Decision Engine, an automated underwriting system], reduce policy exception levels, improve the pricing models, build our sub-prime collection capability, improve our modeling etc. We need to listen to our instincts about the overheated housing market and the likely outcome in our primary markets. We need to build further credibility with the regulators about the control exercised over our SFR underwriting and sub-prime underwriting particularly in LBMC." |393|
Mr. Vanasek retired in December 2005, in part, because the management support for his risk policies and culture was lacking. |394| When Mr. Vanasek left WaMu, the company lost one of the few senior officers urging caution regarding the high risk lending that came to dominate the bank. After his departure, many of his risk management policies were ignored or discarded. For example, by the end of 2007, stated income loans represented 73% of WaMu's Option ARMs, 50% of its subprime loans, and 90% of its home equity loans. |395|
Ronald Cathcart was hired in December 2005 to replace Mr. Vanasek, and became the Chief Enterprise Risk Officer. He had most recently been the Chief Risk Officer for Canadian Imperial Bank of Commerce's retail bank. |396| Although the High Risk Lending Strategy was well underway, after Mr. Vanasek's departure, risk management was in turmoil. Mr. Cathcart testified at the Subcommittee hearing: "When I arrived at WaMu, I inherited a Risk Department that was isolated from the rest of the bank and was struggling to be effective at a time when the mortgage industry was experiencing unprecedented demand for residential mortgage assets." In early 2006, the bank reorganized WaMu's risk management. |397| Under the new system, much of the risk management was subordinated to the WaMu business divisions, with each business division's Chief Risk Officer reporting to two bosses, Mr. Cathcart and the head of the business unit to which the Risk Officer was assigned. WaMu referred to this system of reporting as a "Double-Double." |398|
Cheryl Feltgen, for example, was the Chief Risk Officer for the Home Loans division. She reported both to Mr. Cathcart and to Mr. Schneider, the Home Loans President, setting up a tension between the two. |399| Mr. Schneider had hired Ms. Feltgen from Citi Mortgage, where she had been the Chief Marketing Officer, not a risk manager. Mr. Cathcart told the Subcommittee that he would not have hired her for the role, because of her lack of risk management experience. |400|
Ms. Feltgen told the Subcommittee that, although she was the Home Loans Chief Risk Officer, she also had responsibility to meet business goals. She indicated that she did not see her role as one of risk minimization, but rather of risk optimization. |401| Her 2007 performance evaluation reflected her dual responsibilities, but clearly subordinated her risk management duties to the achievement of business growth objectives. For example, the evaluation identified a series of goals and assigned each a percentage weighting to determine their precedence. Instead of assigning priority to her performance in the area of managing risk, Ms. Feltgen's number one performance goal for 2007 was "GROWTH" in home loans, given a weighting of 35%, followed by "RISK MANAGEMENT," given a weighting of only 25%. |402| Her performance review even listed specific sales targets:
1. Achieve Net Income - $340 MM for 2007
2. HL [Home Loan] Product Sales (Incl. Conduit)
1. Home Equity - $18B
2. Subprime - $32B
3. Option ARM - $33B
4. Alt A - $10B
3. Customer Satisfaction (Total HL) – 55%" |403|
By conditioning her evaluation on whether her division hit pre-determined sales figures, the performance evaluation made her compensation more dependent upon the Home Loans division hitting revenue growth and product sales than upon her contributions to risk management.
Further complicating matters were Ms. Feltgen's two supervisors. In an interview, Ms. Feltgen stated that Ron Cathcart, her supervisor on risk matters, was "not well respected" and did not have "a strong voice." |404| On the other hand, she described David Schneider, her supervisor on loan origination matters, as having a strong voice and acting more as her boss. This arrangement again de-emphasized the importance of her risk duties.
Ms. Feltgen's dedication to the growth of the Home Loans business is apparent in her communications with her staff. For example, on December 26, 2006, she sent a year-end email to her staff. Under the subject line, "Year-End 2006 Message for the Home Loans Risk Management Team," Ms. Feltgen wrote:
"As we approach the close of 2006, it is fitting to reflect on the challenges and accomplishments of this past year and to look forward to 2007 and beyond. Earlier this year David Schneider and the leadership team of Home Loans articulated a new business strategy that included: (1) a shift to higher margin products (Alt-A, subprime and home equity); (2) reducing market risk… and taking on more credit risk and (3) aggressively attacking the cost structure. We have made great strides as a business on all of those fronts and you have all been a part of those accomplishments. You have partnered successfully with the business units of Home Loans in pursuit of our collective goal to drive profitable growth with the right balance of risk and return." |405|
The email continued with a list of "accomplishments of the Home Loans Risk Management Team in support of business goals," that included the following accomplishment: "Our appetite for credit risk was invigorated with the expansion of credit guidelines for various product segments including the 620 to 680 FICO, low docs and also for home equity." |406| The email continued with Ms. Feltgen stating her commitment to the High Risk Lending Strategy and emphasizing revenue and sales despite an acknowledgement of the worsening condition of the mortgage market:
"The year 2007 will be another challenging year for the mortgage industry with mortgage origination volumes down, the inverted yield curve putting pressure on profitability and gain on sale margins at lower level than prior years. The focus on the three key elements of our 2006 strategy remains important: shift to higher margin products, reduce market risk and increase credit risk and attack the cost structure. … In 2007, we must find new ways to grow our revenue. Home Loans Risk Management has an important role to play in that effort.
"David Schneider has encouraged us to ‘BE BOLD'…. Recognize that ‘we are all in sales' passionately focused on delivering great products and service to our customers." |407|
Ms. Feltgen's year-end bonus was based upon her performance review. |408| According to Mr. Cathcart, in 2007, the bank made bonus distributions more dependent on the performance of each business line, rather than the performance of the bank as a whole, which largely removed his control over compensation of his risk managers. Mr. Cathcart told the Subcommittee that he disagreed with this change because it made his risk managers, who reported to him and to the heads of the business units, more beholden to the business heads. Mr. Cathcart said he approached the head of Human Resources, and strongly objected to the change, but was told to take it up with Mr. Killinger. Mr. Cathcart told the Subcommittee that he voiced his objection to Mr. Killinger, but Mr. Killinger told him to talk to Mr. Rotella. He said that he took his objection to Mr. Rotella, but was unsuccessful at preventing the policy change.
Mr. Cathcart told the Subcommittee that this change created further separation between him and his risk managers, and compromised the independence of risk management. |409| He testified at the Subcommittee hearing:
Mr. Cathcart: The chairman adopted a policy of what he called double reporting, and in the case of the Chief Risk Officers, although it was my preference to have them reporting directly to me, I shared that reporting relationship with the heads of the businesses so that clearly any of the Chief Risk Officers reporting to me had a direct line to management apart from me.
Senator Coburn: And was that a negative or a positive in terms to the ultimate outcome in your view?
Mr. Cathcart: It depended very much on the business unit and on the individual who was put in that double situation. I would say that in the case of home loans, it was not satisfactory because the Chief Risk Officer of that business favored the reporting relationship to the business rather than to risk. |410|
The subordination of risk management to sales was apparent at WaMu in many other ways as well. Tony Meola, the head of home loans sales, reported directly to David Schneider. He had direct access to Mr. Schneider and often pushed for more lenient lending standards. According to Ms. Feltgen, the sales people always wanted more lenient standards and more mortgage products, and Mr. Meola advocated for them. |411|
One example was the 80/20 loan, which consisted of a package of two loans issued together, an 80% LTV first lien and a 20% LTV second lien, for a total CLTV of 100%. Ms. Feltgen said she was nervous about the product, as a 100% CLTV was obviously very risky. WaMu's automatic underwriting system was not set up to accept such loans, but Mr. Meola wanted permission to "side step" the systems issue. |412| Mr. Schneider approved the product, and Ms. Feltgen ultimately signed off on it. She told the Subcommittee that it was a high risk product, but was priced accordingly, and that it might have been successful if housing prices had not declined. |413|
When the housing market began to collapse, a time in which prudent risk management became even more critical, Mr. Cathcart, the Chief Enterprise Risk Manager, was accorded even less deference and authority. Mr. Cathcart testified at the April 13th hearing:
"Financial conditions… deteriorated further in 2007 and 2008. As head of risk, I began to be excluded from key management decisions. By February 2008, I had been so fully isolated that I initiated a meeting with the Director, where I advised that I was being marginalized by senior management to the point that I was no longer able to discharge my responsibilities as Chief Enterprise Risk Officer of WaMu. Within several weeks, I was terminated by the Chairman." |414|
During his interview with the Subcommittee Mr. Cathcart provided additional detail about his marginalization by senior management. |415| He said that he initially had extensive interaction with the WaMu Board of Directors and presented to the full Board every six months. According to Mr. Cathcart, he attended all of the Board meetings until the end of 2007 or the beginning of 2008, at which time he was no longer invited. Mr. Cathcart felt he was excluded from Board meetings and calls with investment bankers because he was forthright about WaMu's mortgage loss rates, whereas senior management used older, more favorable numbers. According to Mr. Cathcart, during one of the last Board meetings he attended, after a presentation on expected mortgage losses, he interjected that the loan loss data being presented were already out of date, and the real figures would be much worse. He also recalled speaking up in a 2007 conference call with investment bankers to correct an overly optimistic loss figure. According to Mr. Cathcart, he was chastised for his corrections by WaMu management and told to leave the credit discussions to another senior manager.
Mr. Cathcart told the Subcommittee that regulators were also given out-of-date loss projections as the situation worsened, because Mr. Killinger and Mr. Rotella wanted to prevent a negative reaction. Mr. Cathcart said that the loss rates were increasing every week, and the regulators were being provided with three-week old information. Mr. Cathcart told the Subcommittee that in February or March 2008, he discovered that Mr. Killinger had provided the Director of OTS, John Reich, with out-of-date loss rates. Mr. Cathcart said that he called a meeting with Mr. Dochow, head of the OTS West Regional Office, and provided him with the current numbers. Mr. Cathcart said that Mr. Killinger found out about the meeting and was upset. In April, Mr Killinger fired Mr. Cathcart.
206. See 1/2007 Washington Mutual Presentation, "Subprime Mortgage Program," Hearing Exhibit 4/13-5 (slide showing Long Beach Annual Origination Volume). [Back]
207. 4/2005 OTS internal email, Hearing Exhibit 4/13-8(a). [Back]
208. Subcommittee interview of Faye Chapman, WaMu General Counsel (2/9/2010). See also 12/21/2005 OTS memorandum, "Long Beach Mortgage Corporation (LBMC)," OTSWMS06-007 0001010, Hearing Exhibit 4/16-31. [Back]
209. 1/13/2004 report on "Joint Visitation Dated October 14, 2003," jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b (citing a Long Beach quality assurance report). [Back]
210. Id. [Back]
211. Id. (citing a Long Beach Corporate Credit Review report). [Back]
212. Id. [Back]
213. Id. [Back]
214. Subcommittee interview of Fay Chapman (2/9/2010). [Back]
215. 1/13/2004 report on "Joint Visitation Dated October 14, 2003," jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b. [Back]
216. Subcommittee interview of Fay Chapman (2/9/2010). See also 12/21/2005 OTS memorandum, "Long Beach Mortgage Corporation (LBMC)," OTSWMS06-007 0001010, Hearing Exhibit 4/16-31 ("In 2003, adverse internal reviews of LBMC operations led to a decision to temporarily cease securitization activity. WMU's Legal Department then led a special review of all loans in LBMC's pipeline and held-for-sale warehouse in order to ensure file documentation adequately supported securitization representations and warranties and that WMI was not exposed to a potentially significant contingent liability. Securitization activity was reinstated in early 2004 after the Legal Department concluded there was not a significant liability issue."). [Back]
217. Undated memorandum from Dave Griffith to Michelle McCarthy, "Sub Prime Chronology," likely prepared in early 2007, JPM_WM02095572. [Back]
218. 11/24/2004 email from Michael Smith to Mark Hillis and others, "LBMC Transfer of Piggiebacks from HFS to HFI," JPM_WM01407692. [Back]
219. 11/1/2005 "LBMC Post Mortem – Early Findings Read Out," prepared by WaMu, JPM_WM03737297, Hearing Exhibit 4/13-9. [Back]
220. Id. [Back]
221. 4/17/2006 WaMu memorandum to the Washington Mutual Inc. and WaMu Board of Directors' Audit Committee, "Long Beach Mortgage Company - Repurchase Reserve Root Cause Analysis," prepared by WaMu General Auditor, JPM_WM02533760-61, Hearing Exhibit 4/13-10. [Back]
222. Id. (Long Beach "experienced a dramatic increase in EPD's [early payment defaults], during the third quarter of 2005 [which] … led to a large volume of required loan repurchases. The unpaid principal balance repurchased as a result of the EPD provision for the year ended December 31, 2005 was $837.3 million. The net loss from these repurchases was approximately $107 million."). [Back]
223. Id. [Back]
224. Id. [Back]
225. Washington Mutual Inc. 2005 10-K filing with the SEC. [Back]
226. 9/21/2005 WaMu audit of Long Beach, JPM_WM04656627. [Back]
227. Id. [Back]
228. Subcommittee interview of David Schneider (2/17/2010). [Back]
229. See, e.g., 12/21/2005 OTS memorandum, "Long Beach Mortgage Corporation (LBMC)," OTSWMS06-007 0001009, Hearing Exhibit 4/16-31. [Back]
230. Id. at OTSWMS06-007 0001009 (stating WaMu filed a 12/12/2005 application to acquire Long Beach). [Back]
231. Id. at OTSWMS06-007 0001010. [Back]
232. Id. at OTSWMS06-007 0001011. [Back]
233. See, e.g., 6/3/2005 OTS internal memorandum by OTS examiner to OTS Deputy Regional Director, at OTSWMS06-007 0002683, Hearing Exhibit 4/16-28. [Back]
234. See 12/21/2005 OTS memorandum, "Long Beach Mortgage Corporation (LBMC)," OTSWMS06-007 0001009, Hearing Exhibit 4/16-31. [Back]
235. "Washington Mutual Regulators Timeline," chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j. [Back]
236. 4/27/2006 email from Steve Rotella to Kerry Killinger, JPM_WM05380911, Hearing Exhibit 4/13-11. [Back]
237. 9/14/2006 WaMu internal email, Hearing Exhibit 4/13-12. [Back]
238. Id. [Back]
239. 11/7/2006 WaMu internal email, Hearing Exhibit 4/13-50. [Back]
240. See 6/5/2007 memorandum by Christopher Hovik, Examination Specialist, sent to FDIC Dedicated Examiner Steve Funaro, "WaMu – Long Beach Mortgage Company (LMC) Repurchases," at 1, FDIC_WAMU_000012348, Hearing Exhibit 4/13-13b. [Back]
241. Id. [Back]
242. Id. [Back]
243. Id. at 3. [Back]
244. 12/22/2006 email from Steve Funaro to David Schneider, Hearing Exhibit 4/13-13a. [Back]
245. 12/2006 WaMu internal email, Hearing Exhibit 4/13-13a. [Back]
246. 12/7/2006 email from Ron Cathcart to his colleagues, Hearing Exhibit 4/13-15. [Back]
247. 1/2/2007 email from Ron Cathcart to Cory Gunderson, Hearing Exhibit 4/13-16. [Back]
248. Id. [Back]
249. 2/2007 email chain among WaMu personnel, JPM_WM00673101-03, Hearing Exhibit 4/13-17. [Back]
250. Id. at JPM_WM00673103. [Back]
251. Id. at JPM_WM00673101. [Back]
252. Id. [Back]
253. "Quarterly Credit Risk Review SubPrime," prepared by WaMu Home Loans Risk Management (1st Quarter, 2007), Hearing Exhibit 4/13-18. [Back]
254. Id. [Back]
255. 9/28/2007 "Wholesale Specialty Lending-FPD," WaMu Corporate Credit Review, JPM_WM04013925, Hearing Exhibit 4/13-21. [Back]
256. Id. at 2. [Back]
257. Id. at 3. [Back]
258. 7/10/2007-7/12/2007 excerpts from Standard & Poor's and Moody's Downgrades, Hearing Exhibit 4/23-99. [Back]
259. 8/20/2007 "Long Beach Mortgage Loan Origination & Underwriting," WaMu audit report, JPM_WM02548939, Hearing Exhibit 4/13-19 [Back]
260. Id. at JPM_WM02548940-41. [Back]
261. 8/21/2007 email from Steve Rotella to Randy Melby, JPM_WM04859837, Hearing Exhibit 4/13-20. [Back]
262. "Washington Mutual Regulators Timeline," chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j. [Back]
263. "Securitizations of Washington Mutual Subprime Home Loans," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c. [Back]
264. April 13, 2010 Subcommittee Hearing at 22. [Back]
265. Id. at 22. [Back]
266. Id. at 23. [Back]
267. Id. at 55. [Back]
268. Id. at 90. [Back]
269. Id. at 86. [Back]
270. 11/13/2008 "Worst Ten in the Worst Ten," document prepared by the Office of the Comptroller of the Currency, http://www.occ.treas.gov/news-issuances/news-releases/2009/nr-occ-2009-112b.pdf, Hearing Exhibit 4/13-58. [Back]
271. 8/23/2007 email from Mr. Rotella to Mr. Killinger, JPM_WM00675851, Hearing Exhibit 4/13-79. [Back]
272. Subcommittee interview of Steve Rotella (2/24/2010). [Back]
273. See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001482, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See also, e.g., 12/17/2004 email exchange among WaMu executives, "Risks/Costs to Moving GSE Share to FH," JPM_WM05501400, Hearing Exhibit 4/16-88 (noting that Fannie Mae "is well aware of our data integrity issues (miscoding which results in misdeliveries, expensive and time consuming data reconciliations), and has been exceedingly patient."). [Back]
274. See, e.g., OTS examination reports cited in Chapter IV, below. [Back]
275. 8/13/2004 email from Lawrence Carter to Michal Finn, Finn_Michael-00005331. [Back]
276. 2/7/2005 OTS Letter to Washington Mutual Board of Directors on Matters Requiring Board Attention, OTSWMEF-0000047591, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See the Regulator Chapter of this Report for more information. [Back]
277. 6/3/2005 OTS Findings Memorandum, "Single Family Residential Home Loan review," OTSWME05-004 0000392, Hearing Exhibit 4/16-26. For more information, see Chapter IV, below. [Back]
278. 3/14/2005 OTS Report of Examination, OTSWMS05-004 0001794, Hearing Exhibit 4/16-94 [Sealed Exhibit]. (Examination findings were issued to WaMu on August 28, 2005.) [Back]
279. See, for example, 5/23/2006 OTS Exam Finding Memo, "Home Loan Underwriting, " OTSWMS06-008 0001299, Hearing Exhibit 4/16-33; and 8/29/2006 OTS Report of Examination, OTSWMS06-008 0001690, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]
280. 5/31/2007 Draft OTS Findings Memorandum, "Compliance Management Program," Franklin_Benjamin- 00020408_001, Hearing Exhibit 4/16-9. [Back]
281. 4/2010 IG Report, at 23, Hearing Exhibit 4/16-82. [Back]
282. Id. at 23. [Back]
283. Id. [Back]
284. Id. at 24. [Back]
285. Id. [Back]
286. 11/16/2005 "Retail Fraud Risk Overview," prepared by WaMu Credit Risk Management, at JPM_WM02481938, Hearing Exhibit 4/13-22b. [Back]
287. 12/12/2006 WaMu Market Risk Committee Minutes, JPM_WM02095545, Hearing Exhibit 4/13-28. [Back]
288. 4/2010 IG Report, at 24-25, Hearing Exhibit 4/16-82. [Back]
289. 6/7/2007 OTS Asset Quality Memo 11, "Broker Credit Administration," Hedger_Ann-00027930_001, Hearing Exhibit 4/16-10. [Back]
290. 10/4/2006 "Interagency Guidance on Nontraditional Mortgage Product Risks," (NTM Guidance), 71 Fed. Reg. 192 at 58609. [Back]
291. Id. at 58615. [Back]
292. 12/2006 "Home Loans – SubPrime Quarterly Credit Risk Review," JPM_WM04107374, Hearing Exhibit 4/13- 14. [Back]
293. Id. at JPM_WM04107375. [Back]
294. April 13, 2010 Subcommittee Hearing at 16. [Back]
295. 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. [Back]
296. See, e.g., NTM Guidance at 58614 ("Institutions increasingly rely on reduced documentation, particularly unverified income, to qualify borrowers for nontraditional mortgage loans."). The NTM Guidance directed banks to use stated income loans "with caution," but did not prohibit them or even issue guidance limiting their use. Id. at 58611, 58614. [Back]
297. April 13, 2010 Subcommittee Hearing at 41. [Back]
298. "Saying Yes, WaMu Built Empire on Shaky Loans," New York Times (12/27/08). When asked about this press report, WaMu told the Subcommittee that it had no record of this loan, but could not deny that the incident took place as reported. See also, in the following subsection, a WaMu loan issued to a "Sign Designer" who claimed earnings of $34,000 per month. [Back]
299. See 10/8/1999 "Interagency Guidance on High LTV Residential Real Estate Lending," http://www.federalreserve.gov/boarddocs/srletters/1993/SR9301.htm. [Back]
300. 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. [Back]
301. 2/2005 email chain between Timothy Bates, Tony Meola, Mr. Rotella and others, JPM_WM00616783-84. [Back]
302. 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. See also 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC, at 52 (showing that, as of 12/31/2006, WaMu held $7.4 billion in home mortgages without private mortgage insurance or government guarantees with LTV ratios in excess of 80%, and $15 billion in home equity loans and lines of credit with LTV ratios in excess of 80%). [Back]
303. 6/13/2006 email from Cheryl Feltgen to David Schneider who forwarded it to Steve Rotella, JPM_WM01311922-23. [Back]
304. 6/14/2006 email from Mark Hillis to Cheryl Feltgen, included in a longer email chain involving Mr. Rotella and Mr. Schneider, among others, JPM_WM01311922. [Back]
305. See, e.g., 6/2006 email chain between Mr. Rotella, Mr. Schneider, Mr. Hillis, and Ms. Feltgen, JPM_WM01311922-23. [Back]
306. See NTM Guidance at 58614. See also SEC v. Mozilo, Case No. CV09-03994 (USDC CD Calif.), Complaint (June 4, 2009), at ¶ 50 (quoting an email by Countrywide CEO Angelo Mozilo who, when discussing the 80/20 loans being issued by his bank, wrote: "In all my years in the business I have never seen a more toxic pr[o]duct."). [Back]
307. Id.; Subcommittee interview of Cheryl Feltgen (2/6/2010). 2/2006 WaMu internal email chain, "FW: 80/20," JPM_WM03960778. See also 3/19/2007 email from Ron Cathcart to David Schneider, JPM_WM02571598, Hearing Exhibit 4/16-75 (indicating WaMu issued loans with CLTVs in excess of 95% until ending the practice in March 2007). [Back]
308. See 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC at 56. [Back]
309. 9/15/2005 email from Darrel Dochow to OTS Examiner-In-Charge at WaMu, OTSWMS05-002 0000537, Hearing Exhibit 4/16-6. The "fully indexed rate" is the prevailing interest rate in the published index to which an adjustable rate mortgage is tied, plus the additional percentage points that the lender adds to the index value to calculate the loan's interest rate. See NTM Guidance at 58614, n.5. [Back]
310. Id. [Back]
311. 11/30/2007 email from David Schneider to John McMurray, Kerry Killinger and others, JPM_WM05382127-28. [Back]
312. NTM Guidance at 58614. [Back]
313. Id. [Back]
314. 3/19/2007 email from Ron Cathcart to David Schneider, JPM_WM02571598, Hearing Exhibit 4/16-75. [Back]
315. See, e.g., OTS document, "Hybrid ARM Lending Survey" (regarding WaMu), undated but the OTS Examiner-in- Charge estimated it was prepared in March or mid-2007, JPM_WM03190673 ("For Subprime currently up to 100% LTV/CLTV with 50% DTI is allowed for full Doc depending on FICO score. Up to 95% LTV/CLTV is allowed with 50% DTI for Stated Doc depending on FICO score. … For No Income Verification, No Income No Ratio, and No Income No Asset only up to 95% LTV/CLTV is allowed."). [Back]
316. April 13, 2010 Subcommittee Hearing at 17. [Back]
317. 11/17/2005 WaMu internal memorandum, "So. CA Emerging Markets Targeted Loan Review Results," JPM_WM01083051, Hearing Exhibit 4/13-22a. [Back]
318. Id. [Back]
319. Id. [Back]
320. 11/16/2005 "Retail Fraud Risk Overview," prepared by Credit Risk Management, JPM_WM02481934, Hearing Exhibit 4/13-22b. [Back]
321. Id. at JPM_WM02481940. [Back]
322. Id. at JPM_WM02481936. [Back]
323. Id. at JPM_WM02481936. [Back]
324. Id. at JPM_WM02481938. [Back]
325. Id. at JPM_WM02481943. [Back]
326. Id. at JPM_WM02481948. [Back]
327. 8/29/2005 email from Jill Simons to Tim Bates, JPM_WM04026076-77, Hearing Exhibit 4/13-23b. [Back]
328. 8/30/2005 email from Tim Bates to Jim Vanasek and others, JPM_WM04026075, Hearing Exhibit 4/13-23b. [Back]
329. April 13, 2010 Subcommittee Hearing at 28. [Back]
330. 11/18/2005 email from Cheryl Feltgen to Nancy Gonseth on the Risk Mitigation Team and Tim Bates, JPM_WM03535695, Hearing Exhibit 4/13-23a. [Back]
331. Id. [Back]
332. At the Subcommittee's hearing, Mr. Vanasek testified that as much as $1 billion in loans originated out of these two offices per year. April 13, 2010 Subcommittee Hearing at 27. [Back]
333. See, e.g., 3/2006 WaMu email chain, JPM_WM03985880-83. [Back]
334. 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 1, Hearing Exhibit 4/13-24. [Back]
335. Id. at 1. [Back]
336. Subcommittee interview of Benjamin Franklin (2/18/2010). [Back]
337. 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 1, Hearing Exhibit 4/13-24. [Back]
338. Id. at 2. [Back]
339. Id. at 3. [Back]
340. Id. at 7. [Back]
341. Id. [Back]
342. Id. [Back]
343. Id. at 8. [Back]
344. Id. at 9. [Back]
345. Subcommittee interview of Benjamin Franklin (2/18/2010). [Back]
346. 1/7/2008 OTS Asset Quality Memo 22, "Loan Fraud Investigation," JPM_WM02448184, Hearing Exhibit 4/13- 25. [Back]
347. 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 4, Hearing Exhibit 4/13-24. [Back]
348. Subcommittee interview of Brian Minkow (2/16/2010); 5/27/2008 "Internal Investigative Report" on Westlake Home Loan Center, JPM_WM03171384, Hearing Exhibit 4/13-31. See also "Washington Mutual Exits Wholesale Lending Business, Will Close Home-Loan Centers," Mercury News, 4/7/2008, http://blogs.mercurynews.com/realestate/2008/04/07/washington-mutual-exits-wholesale-lending-business-willclose-home-loan-centers. [Back]
349. 5/12/2008 "WaMu Significant Incident Notification (SIN)," JPM_WM05452386, Hearing Exhibit 4/13-30. [Back]
350. Subcommittee interview of Brian Minkow (2/16/2010). See also 2005 "President's Club 2005 - Maui, Awards Night Show Script," Washington Mutual, Home Loans Group, Hearing Exhibit 4/13-63a (stating Mr. O'Brien and Mr. Minkow had produced $1.2 billion in loans in 2005). [Back]
351. Id. [Back]
352. 5/27/2008 "Internal Investigative Report" on Westlake Home Loan Center, JPM_WM03171384, Hearing Exhibit 4/13-31. [Back]
353. 5/12/2008 "WaMu Significant Incident Notification (SIN)," JPM_WM05452386, Hearing Exhibit 4/13-30. [Back]
354. Subcommittee interview of Brian Minkow (2/16/2010). [Back]
355. 5/15/2008 "WaMu Significant Incident Notification (SIN)," JPM_WM05452389, Hearing Exhibit 4/13-32b. [Back]
356. 2/7/2008 Radian Guaranty Inc. review of Washington Mutual Bank loans, JPM_WM02057526, Hearing Exhibit 4/13-33. [Back]
357. Id. at 1. [Back]
358. Id. [Back]
359. Id. at 5. [Back]
360. April 13, 2010 Subcommittee Hearing at 17. [Back]
361. Id. at 30. [Back]
362. 9/8/2008 "WaMu Risk Mitigation and Mortgage Fraud 2008 Targeted Review," JPM_WM00312502, Hearing Exhibit 4/13-34. [Back]
363. See 8/2006 "Option ARM Credit Risk," WaMu presentation, at 3, Hearing Exhibit 4/13-37; 10/17/2006 "Option ARM" draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38. [Back]
364. April 13, 2010 Subcommittee Hearing at 49. [Back]
365. 9/17/2003 "Option ARM Focus Groups – Phase II, WaMu Option ARM Customers," WaMu research report, at 3, Hearing Exhibit 4/13-35. [Back]
366. 8/14/2003 "Option ARM Focus Groups – Phase I, WaMu Loan Consultants and Mortgage Brokers," WaMu research report, at 3, Hearing Exhibit 4/13-36 [emphasis in original]. [Back]
367. 9/17/2003 "Option ARM Focus Groups – Phase II, WaMu Option ARM Customers," WaMu research report, at 4, Hearing Exhibit 4/13-35. [Back]
368. Id. [Back]
369. Id. at 5 [emphasis in original]. [Back]
370. Subcommittee interview of David Schneider (2/17/2010). [Back]
371. See April 13, 2010 Subcommittee Hearing at 50. [Back]
372. 6/5/2006 "e-Flash" from Steve Stein to Retail Production Sales, JPM_WM03246053. [Back]
373. 7/3/2006 "e-Flash" from Steve Stein to Retail Production Sales, JPM_WM04471136-37. [Back]
374. 8/17/2006 "e-Flash" from Steve Stein, Arlene Hyde, and John Schleck to Production and Operations, JPM_WM03277786-87. [Back]
375. 8/18/2006 "e-Flash" from Allen Myers to Retail Production Sales Managers, JPM_WM03277758. [Back]
376. 8/31/2006 "e-Flash" from Mary Ann Kovach to Consumer Direct, JPM_WM03077747. [Back]
377. 10/12/2006 "e-Flash" from Mary Ann Kovach to Consumer Direct, JPM_WM03627448-49. [Back]
378. See, e.g., 11/13/2006 "e-Flash" from Mary Ann Kovack to Consumer Direct, JPM_WM03077089-90. [Back]
379. 2007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). [Back]
380. 2005 Washington Mutual Inc. 10-K filing with the SEC at 27. [Back]
381. Id. [Back]
382. Id. at 55; 3/2007 Washington Mutual Inc. 10-K filing with the SEC at 57. [Back]
383. 4/2010 IG Report, at 9, Hearing Exhibit 4/16-82. [Back]
384. Subcommittee interview of Brian Minkow (2/16/2010). [Back]
385. 4/2010 IG Report, Hearing Exhibit 4/16-82. [Back]
386. Subcommittee interview of Brian Minkow (2/16/2010). [Back]
387. Id. [Back]
388. 10/17/2006 "Option ARM" draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38, chart at 2. [Back]
389. See wamusecurities.com (subscription website maintained by JPMorgan Chase with data on Long Beach and WaMu mortgage backed securities showing, as of January 2011, delinquency rates for particular mortgage backed securities, including WMALT 2006 OA-3 – 57.87% and WAMU 2007-OA4 – 48.43%). [Back]
390. 1/2005 "Higher Risk Lending Strategy ‘Asset Allocation Initiative,'" Washington Mutual Board of Directors Finance Committee Discussion, JPM_WM00302975, Hearing Exhibit 4/13-2a [emphasis in original]. [Back]
391. April 13, 2010 Subcommittee Hearing at 17. [Back]
392. Id. at 32. [Back]
393. 2/24/2005 Washington Mutual memorandum from Jim Vanasek to the Executive Committee, "Critical Pending Decisions," JPM_WM01265462-64. [Back]
394. Subcommittee interview of Jim Vanasek (12/18/2009 and 1/19/2010). [Back]
395. 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. [Back]
396. Subcommittee interview of Ronald Cathcart (2/23/2010). [Back]
397. Id. [Back]
398. Id.; Subcommittee interviews of David Schneider (2/17/2010) and Cheryl Feltgen (2/6/2010). [Back]
399. See April 13, 2010 Subcommittee Hearing at 34; Subcommittee interviews of Mr. Cathcart (2/23/2010), Mr. Schneider (2/17/2010), and Ms. Feltgen (2/6/2010). [Back]
400. Subcommittee interview of Ronald Cathcart (2/23/2010). [Back]
401. Subcommittee interview of Cheryl Feltgen (2/6/2010). [Back]
402. "Performance Review Form: Leadership," Hearing Exhibit 4/13-64 (the form is not dated, but Ms. Feltgen confirmed that it is the 2007 review). [Back]
403. Id. [Back]
404. Subcommittee interview of Cheryl Feltgen (2/6/2010). [Back]
405. 1/3/2007 email from Cheryl Feltgen, "Year-End 2006 Message for the Home Loans Risk Management Team," Hearing Exhibit 4/13-73. [Back]
406. Id. [Back]
407. Id. [Back]
408. Subcommittee Interview of Ronald Cathcart (2/23/2010). [Back]
409. Id. [Back]
410. April 13, 2010 Subcommittee Hearing at 34. [Back]
411. Subcommittee Interview of Cheryl Feltgen (2/6/2010). [Back]
412. See 2/2006 WaMu internal email chain, "FW: 80/20," JPM_WM03960778. [Back]
413. Subcommittee Interview of Cheryl Feltgen (2/6/2010). See also 2/2006 WaMu internal email chain, "FW: 80/20," JPM_WM03960778. [Back]
414. April 13, 2010 Subcommittee Hearing at 19. [Back]
415. Subcommittee interview of Ronald Cathcart (2/23/2010). [Back]
Back to Contents C. High Risk Lending Strategy E. Polluting the Financial System
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