Former WaMu risk officers say warnings were ignored

Top executives of Washington Mutual Bank defended their actions in the years before the savings and loan’s 2008 collapse, but former chief risk officers testified Tuesday that their warnings about reckless bets on the subprime mortgage market largely went unheeded.

James G. Vanasek, who was WaMu’s chief risk officer from 1999 to 2005, told a Senate committee that “at times borrowers were coached to fill out applications with overstated incomes or net worth adjusted to meet the minimum underwriting policy requirements.”

Asked if he ever warned top executives of his concerns, Vanasek replied, “Constantly.”

“I stood in front of thousands of senior Washington Mutual managers and executives at an annual management retreat in 2004 and countered the senior-executive speaker ahead of me on the program who was rallying the troops with the company’s advertising tag line, ‘The Power of Yes,’ ” he said.

“The implication of this statement was that Washington Mutual would find some way to make a loan. The tag line symbolized the management attitude about mortgage lending more clearly than anything that I can tell you,” Vanasek said.

Vanasek and other executives testified before the Senate’s Permanent Subcommittee on Investigations, which released a report this week concluding that the Seattle-based thrift created a “mortgage time bomb” by making subprime loans it knew were likely to go bad and then packaging them into risky securities. Many of the problems stemmed from shoddy loans originated by WaMu’s Southern California subprime unit, Long Beach Mortgage Co.

Former Chief Executive Kerry Killinger said Tuesday that he tried to resolve major problems at that unit and reduce the company’s lending as the housing market began to falter.

“As CEO, I accept responsibility for all of our performance and am deeply saddened and sorry for what happened,” said Killinger, who stepped down shortly before regulators seized the bank and sold it for $1.9 billion to JPMorgan Chase.

“Beginning in 2005, two years before the financial crisis hit, I was publicly and repeatedly warning of the risks of a housing downturn,” he said. “Unlike most of our competitors, we aggressively reduced our residential first-mortgage business.”

Killinger complained that regulators inappropriately seized the bank as it was working through its problems at the height of the financial crisis. He said the thrift was denied government help because it lacked the political connections of major Wall Street firms.

“For those that were part of the inner circle and were too clubby to fail, the benefits were obvious,” he said, citing the bailouts of large banks that soon followed WaMu’s fall. “For those of us outside of the club, the penalties were severe.”

Sen. Carl Levin (D-Mich.), the panel’s chairman, said the investigation found that WaMu executives, seeking greater profits, decided to take more and more risks in the housing market, and that compensation practices rewarded employees based on volume, not quality, of loans.

He said millions of pages of internal documents showed it failed to rein in the riskiest practices until it was too late, and he questioned executives sharply during a nearly seven-hour hearing.

“WaMu held itself out as a well-run, prudent bank that was a pillar of its community,” Levin said. “But in 2005, WaMu formalized what it had already begun to implement: a movement from low-risk to high-risk home loans. That move to high-risk lending was motivated by three little words: gain on sale.”

Levin was referring to the gain to be made by selling the loans to investors. The committee found that WaMu pushed risky mortgages because it made eight times as much selling a subprime loan on Wall Street than it made by selling a traditional fixed-rate loan.

Levin said the committee found that the bank steered customers into high-risk subprime and adjustable-rate mortgages. He also said that, in some cases, the bank took loans in which it had discovered fraudulent activity -- such as misstated income by borrowers -- and rolled them into mortgage securities sold to investors without disclosing the fraud.

Vanasek and Ronald Cathcart, his successor as chief risk officer, along with Randy Melby, the company’s former general auditor, confirmed much of the Senate committee’s findings. Asked if there was a point he knew that WaMu was in trouble, Cathcart said it was similar to “boiling a frog.”

“It happened gradually,” he said.

The Senate investigation uncovered an April 2008 memo from an internal WaMu corporate fraud investigator that said a sales associate had acknowledged that some associates would “manufacture” statements about a potential borrower’s assets “because the pressure was ‘tremendous,’ and they had been told to get the loans funded, ‘whatever it took.’ ”

“Sales associates manufacturing documents, large numbers of loans that don’t meet credit standards, offices issuing loans in which 58[%], 62[%] or 83% contain evidence of fraudulent borrower information, loans marked as containing fraud but then sold to investors anyway,” Levin said. “These are massive, deep-seated problems. And they are problems that . . . were communicated to senior management but were not fixed.”

David Beck, former division head of capital markets at WaMu, said the company informed investors of the “risk characteristic of the loans” and had internal processes, in the event fraud was detected, to remove loans from securities before they were sold.

“Having said that, some fraudulent loans do slip through, some loans with underwriting defects,” he said, adding that investors could force WaMu to buy back such securities.

Killinger said he was unaware of a specific push in late 2006 and early 2007 to quickly sell about $3 billion in securities with potentially fraudulent mortgages.

But Levin was not satisfied. “The issue isn’t that you didn’t know the housing bubble was going to burst,” he told Killinger. “The issue is what did you know about your own company in terms of fraud.”

The committee’s findings were bipartisan. Sen. Tom Coburn of Oklahoma, the panel’s top Republican, criticized WaMu management for deciding “to dive headfirst into high-risk lending.”

“Something is definitely wrong when you need more documentation to rent a movie than to get a million-dollar home loan,” he said.

But Coburn also criticized Congress for failing to properly oversee banking regulators who allowed the problems at WaMu and other financial firms. The commission will hear testimony from regulators Friday about their role in WaMu’s failure.

jim.puzzanghera@

latimes.com

Times staff writer E. Scott Reckard contributed to this report.