Washington Mutual's Failure ~ market folly

Friday, February 20, 2009

Washington Mutual's Failure

Very interesting piece on the rise and fall of Washington Mutual flagged to our attention by Barry Ritholtz. The Jacksonville Business Journal writes,

"But already by 2001 — long before the housing bubble stretched dangerously, before most Americans had heard the term “subprime loan” — Killinger (WaMu Chief Executive) had created the fractures that would cause Washington Mutual to collapse in the largest bank failure in U.S. history. The cracks, according to executives who were there at the time, would spread over the next 10 years, eventually rendering the 119-year-old bank that Killinger painstakingly built into the nation’s largest thrift too weak to withstand the greatest economic downturn of his career. “By the time you got to the last couple of years, pretty much the destiny of the company had been locked in,” said one former executive. Killinger declined repeated requests to be interviewed.


But, without exception, former and current executives interviewed for this article pointed to Killinger’s changes in the late 1990s as one of the chief causes of the company’s eventual downfall. One of the main reasons is that it gave much more power to the company’s mortgage division and the executives who ran it over the next 10 years, executives said. Under the new structure, the mortgage unit operated more on its own, and its independence grew when Killinger gave it its own IT and human resources departments, executives said. “The mortgage unit was responsible for its own bottom line,” said Lannoye. “The checks and balances were gone.” Ultimately, the changes paved the way for the mortgage unit to transform into a “culture of unmitigated greed,” according to a former executive team member, a view echoed by many former WaMu executives.


At the same time as he made the management shift in 1999, Killinger made an acquisition that seemed unremarkable. But Long Beach Financial was different. The California lender was a leader in a growing area of subprime mortgages, which were gaining popularity because banks could charge higher interest rates to those with poor credit, and reap more profit. Long Beach Financial was WaMu’s entry into the market. The highly profitable business made $752 million worth of loans in the first quarter of 1999 alone. Its 12,500 loan brokers were spread across all 50 states.


It marked the start of WaMu’s fateful foray into subprime loans, and its rapid, unchecked advance into risky mortgage lending — ultimately the chief cause of its collapse. Killinger had found a new growth strategy. After Long Beach, WaMu quickly snapped up three more mortgage banks. At the time, even many WaMu executives thought it was a good move. Home prices were rising, interest rates were low and banks earned sizable fees for originating loans. What’s more, the risk of default could be off-loaded by packaging the mortgages and reselling them to investors as securities.


Now the cracks at WaMu started to spread. The company began losing money on hedging — efforts to protect against movements in interest rates, a problem that was partially attributed to a failure to integrate a key mortgage system, according to executives who were present at the time. The bank also began losing money on home loans. Its profit, which had marched dramatically higher, plateaued at about $3.8 billion in 2003. Davis, who had led the home loan group since the late 1990s, left abruptly that year, executives said. The mortgage business, according to one executive, “became the Achilles’ heel of the bank.” The following year, the trouble deepened. Earnings tumbled by 25 percent, or more than $1 billion, the largest decline in annual earnings for at least a decade. More worrying, provisions for bad loans leapt fivefold, to $209 million. WaMu cut 13,450 jobs, closed 100 mortgage offices and closed 53 commercial banking operations.


In the desperate last months, Killinger was described as blindly optimistic and oblivious by those who worked with him. He had not in his career seen a market or a bubble like the one now engulfing Washington Mutual."

Read the entire piece.

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