WaMu execs saw warning signs of deteriorating loans

Washington Mutual and its lenders were making so much money on subprime mortgages and other risky loans that they couldn't stop — even when senior managers and regulators told them to.

Internal company documents obtained by the Senate's Permanent Subcommittee on Investigations show that despite concerns inside and outside WaMu that its loans were failing at exceptionally high rates and were riddled with fraud, the abuses continued right up to the collapse of the subprime market in 2007.

David Schneider, head of WaMu's home-loans operation, said in a December 2006 email that the company was being asked to buy back more and more subprime loans that were defaulting soon after WaMu sold them off: "Short story is this is not good... We are all rapidly losing credibility as a management team."

Three months earlier, chief operating officer Steve Rotella called the situation at Long Beach "terrible," with "repurchases, (early payment defaults), manual underwriting, very weak servicing/collections practices and a weak staff."

Later, in August 2007, Rotella said that he had once considered WaMu's regular home-loans operation "the worst managed business I had seen in my career." He added: "That is, until we got below the hood of Long (B)each."

Problems abounded even among WaMu's allegedly prime home loans, according to documents the Senate subcommittee will make public at its Tuesday hearing on WaMu.

A November 2005 review of loans in southern California found "an extensive level of loan fraud...virtually all of it stemming from employees in these areas circumventing bank policy surrounding loan verification and review."

At one California office, 58 percent of loans examined in an internal review were fraudulent; at another, 83 percent.

Tuesday's hearing will go over much of what has become familiar ground to WaMu watchers: the thrift's headlong plunge into the murky world of subprime loans, pay-option adjustable-rate mortgages, no-documentation loans and other "innovations" that eventually killed WaMu and nearly sank the rest of the financial system.

The company, subcommittee chairman Carl Levin said, seemed to be focused on feeding investment banks' insatiable appetite for high-risk loans that could be bundled, sliced up, sprinkled with financial fairy dust and sold as investment-grade securities.

"This was a Main Street bank that was taken in by the Wall Street profits that were offered to it if it churned out mortgages," said Levin, a Michigan Democrat. WaMu, he said, "got turned into a securitization factory."

Between 2000 and 2007, the subcommittee found, WaMu and Long Beach together sold more than $77 billion of subprime mortgages to investors, along with billions more in other high-risk loans.

The reason WaMu turned to high-volume securitization was simple. According to a 2006 presentation to WaMu's board of directors, option ARMs were almost six times as profitable as traditional fixed-rate loans when sold off; subprime mortgages were nearly eight times as profitable.

When its primary regulator, the federal Office of Thrift Supervision, tried to rein in WaMu's lending practices, the company resisted.

WaMu's signature product, the option ARM, allowed borrowers to make interest-only payments — or even smaller payments that wouldn't even cover accrued interest — for five years or until the amount owed reached a certain cap.

The loan then "recast," with new, often much higher, monthly payments meant to pay off the total amount. Typically, though, option ARM borrowers would refinance before hitting the recast point.

OTS, concerned that too many of the lenders it regulated were playing fast and loose with mortgage rules, issued guidance in October 2006 saying that borrowers needed to be qualified based on the recast interest rate, not the lower introductory rates.

A March 2007 internal WaMu email said that if the change were implemented, loan volume would drop by a third. WaMu asked for more time; the OTS let it defer for a year.

But by that new deadline, WaMu would be gone, a chapter in the history of the greatest financial crisis in decades — a crisis WaMu itself helped create.

WaMu, Levin said, "built a conveyor belt that dumped toxic mortgage assets into the financial system like a polluter dumping toxic substances into a river."

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com