The Lost Bank: The Story of Washington Mutual

Kirsten Grind, “The Lost Bank: The Story of Washington Mutual—The Biggest Bank Failure in American History” Simon & Schuster, 2012, 344 pp.

Before I get into the details of the book, I have some reflections to share that occurred to me as I was reading this recent, of many other, books I have read regarding the 2008 financial crisis:

*I believe 15 and 30 year fixed rate loans have to end.  Only adjustable rate loans make sense to me. How are banks going to survive if we return to ‘normal’ times with inflation at 3 to 4 or more percent and they are holding fixed-rate loans paying only 3.375%?

*Compensation systems drive behavior—PERIOD.

“The Lost Bank” is largely the story of the overweening ambition and willful blindness of WaMu’s longtime chief executive, Kerry Killinger, who through a flurry of bold acquisitions turned the well-run local thrift into a national banking powerhouse churning out sub-prime mortgages by commission-soaked sales executives.

My Notes:

Pg. 11:  In 1981 Washington Mutual and thousands of other banks were about to collapse.  Interest rates had shot up past 20 percent, forcing the banks to pay a high rate on certificates of deposit while receiving a low interest rate payment from loan customers, most of whom had 30-year fixed-rate mortgages.  Over the next few years, the federal government would step in and rescue more than four dozen banks.  CEO Pepper took Washington Mutual public, raising about $75 million, enough to save the bank.  As a mutual bank, Washington Mutual was owned by its depositors, a structure not unlike that of a modern-day credit union.  After it went public, it became a savings bank owned by its shareholders.  (Both mutual and savings banks are known as ‘thrifts,’ because they deal with consumers, rather than businesses like commercial banks.)

Pg. 15:  In 1994 the federal government passed legislation allowing bank holding companies to buy banks in other states.  This began the growth of banks.

Pg. 22:  By the early 1990s, about 10 percent of homeowners held adjustable rate mortgages.  However, unlike most, Washington Mutual’s (WaMu) ARM wouldn’t charge a customer more than a two-percentage-point increase when the loan adjusted.  Also, the bank gave customers the unusual option of changing to a fixed-rate loan without going through the hassle of refinancing.  By 1998, Washington Mutual was the seventh-largest financial institution in the US, going from $1 billion in assets in 1981 to $150 billion.

Pg. 59:  In 1997, Washington Mutual, wanting to remain competitive, bought Long Beach, a subprime company.  Also, this purchase would quiet local community organizations that protested every bank purchase because loans to poorer communities were inadequate.  Under the requirements of the federal Community Reinvestment Act, Washington Mutual had to lend a certain amount of money to these groups.  (Congress passed the Act in 1977 to reduce discriminatory credit practices against low-income neighborhoods, a practice known as redlining.)

Pg. 64: In 1995, the Clinton administration rolled out a plan to boost homeownership from 64 percent to 67.5, adding 8 million new homeowners within five years.  Fannie and Freddie, the government-sponsored entities that purchased the bulk of mortgages from banks, announced that they would ease up credit requirements.

Pg. 119:  By 2005 fixed-rate mortgages made up less than a third of all mortgages at WaMu.  They were not alone, an entire country of lenders had shifted toward short-term lending, a change blessed by Alan Greenspan. 

Pg. 134:  By 2005, nearly a quarter of all homes sold in the previous year had been purchased by people who had no intention of living in them.  At the end of 2005, nearly half of the loans in WaMu’s $70 billion Option ARM portfolio were negatively amortizing.  Then in 2006, for the first time in eleven years, the median price of existing homes nationwide declined.  The 1.7 percent drop was the second-largest year-to-year decrease in home prices since the National Association of Realtors started keeping track thirty-eight years earlier, in 1968. (p. 151)

Pg. 167:  In late July 2007 the subprime market collapsed with the failure of two hedge funds run by Bear Stearns. 

Pg. 224:  The regulator of WaMu, the Office of Thrift Supervision (OTS), between 2003 and 2008 noted more than 500 problems at WaMu.  But the 500 concerns sparked little action at the bank.  WaMu did move out nine different chief compliance officers in just seven years and this too concerned the OTS.  Part of the problem was that WaMu kept making money as the housing market kept going up, so it was a challenge for the regulatory agency to object to what it was doing.  (The OTS is one of the few regulatory agencies to be discontinued by Congress, marking the end of the savings and loan industry)

Pg. 254:  On September 7, 2008 CEO Kerry Killinger of WaMu was finally forced out—he had been in charge since 1990.  This was the same day the government took over Fannie and Freddie.  The FDIC then took over WaMu and sold its assets to JPMorgan.  The failure of WaMu was eight times the size of the 1980s Continental Illinois’s failure.  (In 2010, JPMorgan posted record earnings of $17 billion, up nearly 50 percent from the previous year.  The purchase of WaMu—and Bear Stearns—catapulted JPMorgan to a Forbes ranking as the largest company in the world.)

Pg. 314:  The day after WaMu’s failure, customers now focused on the bank Wachovia and began pulling their money out of that bank.  By the end of the day, Wachovia had lost $5 billion—double the amount of any day during WaMu’s run—and its stock plummeted 27 percent.  The FDIC then declared Wachovia a ‘systemic risk’ which then allowed the government to step in and provide money to save the bank.  The government brokered a purchase of Wachovia by Wells Fargo, saving it.  Six days after WaMu’s collapse, congress passed the $700 billion Troubled Asset Relief Program.  Rather than use the money to buy up the bad mortgages from banks, the program morphed into a way for the government to inject capital into companies by buying up preferred stock.  As part of the new legislation, the government increased the deposit insurance limit from $100,000 to $250,000, where it remains to this day.