I spent this past weekend finishing The Lost Bank: The Story of Washington Mutual–The Biggest Bank Failure in American History, Kirsten Grind’s behind-the-scenes look at the decline and fall of what was once the country’s third-biggest mortgage lender. While I can’t quite say the book is enjoyable—memories of the financial crisis are still too fresh to comfortably re-live in the kind of detail Grind provides—I couldn’t help but keep turning the pages with a kind of morbid fascination. It’s as if Grind has given us a front-row seat to a massive, slow-motion train wreck, and we simply can’t avert our eyes.
That WaMu ended as a train wreck there can be no doubt. Grind (who covered banking for the Puget Sound Business Journal at the time of WaMu’s failure and who now writes for the Wall Street Journal) doesn’t spend much time telling the story of WaMu’s transformation from a floundering thrift back in the early 1980s into one of the titans of the financial services industry. Rather, she focuses on the events that led to the bank’s collapse and its aftermath. You won’t be surprised to learn that two main factors led to the bank’s demise: the nationwide collapse of the U.S. housing market and poor decisions made by WaMu’s management, led by CEO Kerry Killinger. Even so, it was never inevitable (in Grind’s view, at least) that WaMu was doomed. But the company sure didn’t help itself along the way. Let’s take a look at some of the places where Killinger and Co. went wrong.
As both a sell-side bank analyst and then as an investor, I’ve known Kerry Killinger for many years. I was never as close to him as I am to other bank CEOs, but always respected the success he achieved running Washington Mutual. But even well before the company’s meltdown, it was clear that he’d become too disengaged from the day-to-day details of managing the business. Given the length of Killinger’s tenure, that disengagement might have been inevitable. I’ve always believed in informal term limits for CEOs; Kerry Killinger is a good example of why. He was named WaMu’s CEO in 1989 and remained so until the board finally fired him a few weeks before the company’s collapse in 2008. It would have been tough over those 19 years to not have become complacent running the company. In general, I believe CEOs should step down after 10 years.
Here are some specific examples of what I believe were bad management practices in place under Killinger:
1. The company was managed in separate silos. The retail business and the mortgage business at WaMu were run as distinctly separate entities. Bad idea. For starters, the leaders of those two silos didn’t work well together because they were vying to be Killinger’s successor. Killinger himself ran the company much as Ken Lewis ran Bank of America–without the aid and advice of a small senior management group that was interested in what was best for the company as a whole, rather than individual units. Killinger so hated conflict and confrontation that he didn’t force better teamwork among his senior executives. That was devastating in the end.
2. He was obsessed with Wall Street. Killinger spent years complaining about the lack of respect that WaMu got from Wall Street. That in turn led him to spend an inordinate amount of time setting quarterly earnings expectations–and then fixating on beating them. None of this of course did anything to help strengthen WaMu’s basic business, and very likely weakened it.
3. He overemphasized market share.Like Countrywide’s Angelo Mozilo and BofA’s Lewis, Killinger valued size and market share for their own sakes. In lending, that can be a recipe for disaster, since it can often lead to unwarranted price cuts and an imprudent easing of underwriting standards. In 2000, Killinger established a goal for the company to quadruple its market share in residential mortgage loan originations over five years. That didn’t work out so well.
4. He switched to a higher-risk lending strategy at the wrong time. To boost profitability, Killinger approved a “higher-risk lending strategy” in 2004. In hindsight, this of course proved to be disastrous. There’s no way to know for sure how rigorous the analysis was behind this decision. Then again, since so many other lenders were emphasizing subprime at exactly the same time, it’s hard to believe the analysis was very rigorous at all.
5. Killinger had a history of weak risk management.I believe this is an area where he evolved, in a negative way, over time. As WaMu grew over the years with hardly a hiccup, the importance of risk management was consistently deemphasized—in large part because the CEO tended to downplay it or ignore it altogether.
Washington Mutual failed mainly because of the collapse in housing and the resulting loan losses. But Killinger’s management style and decisions sure didn’t help.
The Mortgage Mess
But besides fraud, much of the blame for WaMu’s demise can be laid at plain, old sloppy underwriting–in subprime loans, prime loans, and home equity loans. The company’s subprime mortgage unit, Long Beach Mortgage, ran into underwriting problems in the early 2000s, actually tightened a little, and then went back to its old habits, resulting in major loan problems beginning in 2005. An internal audit revealed that 99% of Long Beach’s first-payment defaults could have been prevented through sounder underwriting.
But the majority of Washington Mutual’s problem loans were in prime mortgage loans and home equity loans. Grind reports that 70% of the option ARM mortgages and 90% of the home equity loans were underwritten on the basis of “stated income” rather than verified income. Good God!
In hindsight, the housing bubble and its attendant bust are obvious and should have been easily preventable. But so many players made so much money in the boom that they totally miscalculated what would happen once the boom ended.
Detail of the Failure
Grind’s account of Washington Mutual’s final six months is as fascinating as it is sad. One especially interesting part of the story was the epic battle between John Reich, head of the OTS, WaMu’s primary regulator, and the FDIC’s Sheila Bair. There was clearly no love lost between the two. Grind also suggests that WaMu could have been saved if it had been allowed to participate in the TARP programs. Mark me down as skeptical.
But we’ll never know. We do know the company lost $17 billion in deposits in the weeks leading up to its failure and know, too, that it would have suffered massive hits to equity as a result of future credit losses. But other companies did survive, albeit usually via massive dilution to existing shareholders as a result of capital raises. Whether Washington Mutual failed on September 25, 2008 or not, existing shareholders would have taken a huge, huge hit. This movie was going to have a bad ending either way.
A Good Read
The Lost Bank is a great read; it provides background and details to the WaMu saga that will be new to most readers. But as a reminder of the greed and mistakes that created the greatest financial collapse of my lifetime, it’s also more than a little depressing. Enjoy it if you can!
What do you think? Let me know!