case study 246

Case Study

The failure of Washington Mutual

Closure of Seattle-based saving and loan association Washington Mutual (WaMu) was by far the biggest bank failure in the history of the United States. The nation’s sixth largest bank, which at one point held $307 billion in assets, was seized by regulators and sold at bargain rice ($1.9 billion) to JP Morgan Chase in 2008. Case agreed to assume WaMu’s debt, which saved taxpayers from having to bail the firm out. Depositors were insured against losses, but WaMu stockholders were wiped out and 18,000 employees lost their jobs.

For decades Washington Mutual had an admirable track record. It has survived as a regional thrift for over a hundred years, weathering both the Great Depression and the savings and loan crisis of the 1980’s. However, WaMu’s ethical climate changed dramatically for the worse when under the leadership of Kerry Killinger, who became the company’s CEO in 1990. CEO Killinger wanted to make WaMu the “Wal-Mart of banking” by offering mortgages and credit cards to lower and middle-income individuals who could not get loans from other financial institutions. To achieve this goal, the fire began a rapid expansion program, buying other thrifts and opening hundreds of branches across country.

Expansion also meant dramatically increasing loan volume and becoming a major player in the subprime mortgage market. Subprime loans are high risk/high margin. They go to consumers who normally couldn’t qualify for home loans due to credit problems or inadequate income. Because they are risky, lenders can charge higher interest and fees. Washington Mutual, along with other major lenders like Countrywide and Wachovia, began to offer a variety of new mortgage products. These included (a) adjustable rate mortgages (ARMs) with low initial interest rates that then adjusted upward, (b) no down payment loans, and (c) flexible payment plans that allowed homeowners to determine how much to pay each month. Some borrowers took advantage of the new mortgage options to get into houses they otherwise couldn’t afford, or to refinance their current residences, using their home equity to buy everything from swimming pools and new cars to expensive electronics. Some consumers never intended to pay their home loans back.

In 2003 WaMu announced its new advertising slogan, “The Power to Say Yes,” which also became the firm’s mantra. Just saying yes meant giving loans to just about everyone who asked for one, regardless of income, credit history, or ability to repay. Little or no documentation was required. In one case, for example, a mariachi singer applied for a loan, claiming earnings of $100,000 or more. To document his claim, the applicant provided a picture of himself, dressed in his mariachi costume, in front of his house. His application was approved.

According to senior mortgage underwriter Keysha Cooper, “At WaMu, it wasn’t about the quality of the loans; it was about the numbers. They didn’t care if we were giving loans to people that didn’t qualify. Instead, it was how many loans did you guys close and fund?” Cooper reports being pressured by brokers and supervisors to approve questionable loans. In one case, when she refused to OK a suspect loan application, she was put on probation and her manager signed off on the mortgage.

WaMu generously rewarded those who helped create high loan volume, further encouraging excessive risk and fraud. Realtors could receive “referral fees” of over $10,000 for steering clients to WaMu. Agents often did not mention this arrangement to home buyers or clearly explain the terms of the loans to borrowers. Brokers could earn $20,000-$30,000 off of a $500,000 mortgage, and top producers were sent on all expenses paid trips to Hawaii and other vacation destinations. Loan officers pushed variable rate loans in particular because they generated higher fees for the officers and higher earnings for the firm. Between 2003 and 2006, the percentage of adjustable rate mortgages at WaMu grew from 25% to 70% of new home loans. The stock price rose, and CEO Killinger reaped a windfall in bonuses. He received over $100 million during his tenure at Washington Mutual, the vast majority during the peak of the firm’s subprime push.

Washing Mutual and its competitors operated under the faulty assumption that housing prices would continue to increase indefinitely (housing markets typically rise and fall). When housing prices declined in 2007-2008, subprime and then prime mortgage defaults soared, igniting the mortgage crisis. Millions had to abandon their homes because they couldn’t afford rising payments, lost their jobs, or now owed more than their homes were worth. Wall Street investment banks (which bought bundles of subprime mortgages and sold them to overseas investors) had to be propped up by the federal government. The stock market crashed, and the world economy headed into a recession.

Washington Mutual was particularly hard hit by the mortgage crisis. The default rate on its subprime loans rose to over 27%, and financial losses mounted. As the firm’s stock price tanked, Killinger was fired, and depositors withdrew $17 billion. The run on the savings and loan prompted its closure and sale. In just a few short weeks, “the giant lender that came to symbolize the excesses of the mortgage boom” was gone.

Question:

1. What signs of an unhealthy, unethical climate do you see at Washington Mutual?

2. What similarities do you see between the WaMu story and other examples of corporate ethical failure?

3. How much responsibility do you place on homeowners for the mortgage crisis and the collapse of Washington Mutual?