Sunday, September 4, 2011


After a short hiatus, WaMu allowed Long Beach to resume securitizing subprime loans in
2004.216 An internal WaMu memorandum, later prepared by a WaMu risk officer who had been
asked to review Long Beach in 2004, recalled significant problems:
“You’ve asked for a chronological recap of ERM [Enterprise Risk Management] market
risk involvement with Longbeach and the sub prime conduit. … [In] 2004: I conducted
an informal but fairly intensive market risk audit of Longbeach …. The climate was very
adversarial. … We found a total mess.”217
A November 2004 email exchange between two WaMu risk officers provides a sense that
poor quality loans were still a problem. The first WaMu risk officer wrote:
“Just a heads-up that you may be getting some outreach from Carroll Moseley (or
perhaps someone higher up in the chain) at Long Beach regarding their interest in
exploring the transfer of … a small amount (maybe $10-20mm in UPB [unpaid principal
balance]) of Piggieback ‘seconds’ (our favorite toxic combo of low FICO borrower and
HLTV loan) from HFS [hold for sale portfolio] to HFI [hold for investment portfolio].
“As Carroll described the situation, these are of such dubious credit quality that they
can’t possibly be sold for anything close to their ‘value’ if we held on to them. … I urged
him to reach out to you directly on these questions. (E.g., it’s entirely possible we might
want to make a business decision to keep a small amount of this crap on our books if it
was already written down to near zero, but we would want all parties to be clear that no
precedent was being set for the product as a whole, etc., etc.).”218
The second risk officer sent the email to the head of Long Beach, with the comment, “I think it
would be prudent for us to just sell all of these loans.”
2005 Early Payment Defaults. Early in 2005, a number of Long Beach loans
experienced “early payment defaults,” meaning that the borrower failed to make a payment on
the loan within three months of the loan being sold to investors. That a loan would default so
soon after origination typically indicates that there was a problem in the underwriting process.
Investors who bought EPD loans often demanded that Long Beach repurchase them, invoking
the representations and warranties clause in the loan sales agreements.
216 Subcommittee interview of Fay Chapman (2/9/2010). See also 12/21/2005 OTS memorandum, “Long Beach
Mortgage Corporation (LBMC),” OTSWMS06-007 0001010, Hearing Exhibit 4/16-31 (“In 2003, adverse internal
reviews of LBMC operations led to a decision to temporarily cease securitization activity. WMU’s Legal
Department then led a special review of all loans in LBMC’s pipeline and held-for-sale warehouse in order to ensure
file documentation adequately supported securitization representations and warranties and that WMI was not
exposed to a potentially significant contingent liability. Securitization activity was reinstated in early 2004 after the
Legal Department concluded there was not a significant liability issue.”).
217 Undated memorandum from Dave Griffith to Michelle McCarthy, “Sub Prime Chronology,” likely prepared in
early 2007, JPM_WM02095572.
218 11/24/2004 email from Michael Smith to Mark Hillis and others, “LBMC Transfer of Piggiebacks from HFS to
HFI,” JPM_WM01407692.
To analyze what happened, WaMu conducted a “post mortem” review of 213 Long
Beach loans that experienced first payment defaults in March, April, and May of 2005.219 The
review found that many early defaults were not only preventable, but that in some instances
fraud should have been easily detected from the presence of “White Out” on an application or a
borrower having two different signatures:
“First Payment Defaults (FPD’s) are preventable and / or detectable in nearly all cases
(~99%)[.] Most FPD cases (60%) are failure of current control effectiveness[.] … High
incident rate of potential fraud among FPD cases[.] … All roles in the origination process
need to sharpen watch for misrepresentation and fraud[.] … Underwriting guidelines are
not consistently followed and conditions are not consistently or effectively met[.] …
Underwriters are not consistently recognizing non-arm’s length transactions and/or
underwriting associated risk effectively[.] … Credit Policy does not adequately address
certain key risk elements in layered high risk transactions[.] …
“66% of reviewed FPD cases had significant variances in the file[.] … Stated Income
should be reviewed more closely ([fraud] incidence rate of 35%) …. Signatures should
be checked – 14% Borrowers signature vary[.] Altered documents are usually detectable
–5% White-out on documentation[.] … 92% of the Purchases reviewed are 100% CLTV
[combined loan-to-value][.] … 52% are Stated Income.”220
A subsequent review conducted by WaMu’s General Auditor of the “root causes” of the
Long Beach loans with early payment defaults pointed not only to lax lending standards and a
lack of fraud controls, but also to “a push to increase loan volume”:
“In 2004, LBMC [Long Beach] relaxed underwriting guidelines and executed loan sales
with provisions fundamentally different from previous securitizations. These changes,
coupled with breakdowns in manual underwriting processes, were the primary drivers for
the increase in repurchase volume. The shift to whole loan sales, including the EPD
provision, brought to the surface the impact of relaxed credit guidelines, breakdowns in
manual underwriting processes, and inexperienced subprime personnel. These factors,
coupled with a push to increase loan volume and the lack of an automated fraud
monitoring tool, exacerbated the deterioration in loan quality.”221
Due to the early payment defaults, Long Beach was forced to repurchase loans totaling
nearly $837 million in unpaid principal, and incurred a net loss of about $107 million.222
219 11/1/2005 “LBMC Post Mortem – Early Findings Read Out,” prepared by WaMu, JPM_WM03737297, Hearing
Exhibit 4/13-9.
220 Id.
221 4/17/2006 WaMu memorandum to the Washington Mutual Inc. and WaMu Board of Directors’ Audit
Committee, “Long Beach Mortgage Company - Repurchase Reserve Root Cause Analysis,” prepared by WaMu
General Auditor, JPM_WM02533760-61, Hearing Exhibit 4/13-10.
222 Id. (Long Beach “experienced a dramatic increase in EPD’s [early payment defaults], during the third quarter of
2005 [which] … led to a large volume of required loan repurchases. The unpaid principal balance repurchased as a
loss overwhelmed Long Beach’s repurchase reserves, leading to a reserve shortfall of nearly $75
million.223 Due to its insufficient loss reserves, its outside auditor, Deloitte and Touche, cited
Long Beach for a serious deficiency in its financial reporting.224 These unexpected repurchases
were significant enough that Washington Mutual Inc., Long Beach’s parent company, made
special mention of them in its 2005 10-K filing:
“In 2004 and 2005, the Company’s Long Beach Mortgage Company subsidiary engaged
in whole loan sale transactions of originated subprime loans in which it agreed to
repurchase from the investor each ‘early payment default’ loan at a price equal to the
loan’s face value plus the amount of any premium paid by the investor. An early
payment default occurs when the borrower fails to make the first post-sale payment due
on the loan by a contractually specified date. Usually when such an event occurs, the fair
value of the loan at the time of its repurchase is lower than the face value. In the fourth
quarter of 2005, the Company experienced increased incidents of repurchases of early
payment default loans sold by Long Beach Mortgage Company and this trend is expected
to continue in the first part of 2006.225
In addition to the early payment default problem, a September 2005 WaMu audit
observed that at Long Beach, policies designed to mitigate the risk of predatory lending practices
were not always followed. The audit report stated: “In 24 of 27 (88%) of the refinance
transactions reviewed, policies established to preclude origination of loans providing no net
tangible benefit to the borrower were not followed.”226 In addition, in 8 out of 10 of the newly
issued refinance loans that WaMu reviewed, Long Beach had not followed procedures designed
to detect “loan flipping,” an industry term used to describe the practice of unscrupulous brokers
or lenders quickly or repeatedly refinancing a borrower’s loan to reap fees and profits but
provide no benefit to the borrower.227
2006 Purchase of Long Beach. In response to all the problems at Long Beach, at the
end of 2005, WaMu fired Long Beach’s senior management and moved the company under the
direct supervision of the President of WaMu’s Home Loans Division, David Schneider.228
Washington Mutual promised its regulator, OTS, that Long Beach would improve.229 The bank
also filed a formal application, requiring OTS approval, to purchase Long Beach from its parent
company, so that it would become a wholly owned subsidiary of the bank.230
result of the EPD provision for the year ended December 31, 2005 was $837.3 million. The net loss from these
repurchases was approximately $107 million.”).
WaMu told OTS
that making Long Beach a subsidiary would give the bank greater control over Long Beach’s
223 Id.
224 Id.
225 Washington Mutual Inc. 2005 10-K filing with the SEC.
226 9/21/2005 WaMu audit of Long Beach, JPM_WM04656627.
227 Id.
228 Subcommittee interview of David Schneider (2/17/2010).
229 See, e.g., 12/21/2005 OTS memorandum, “Long Beach Mortgage Corporation (LBMC),” OTSWMS06-007
0001009, Hearing Exhibit 4/16-31.
230 Id. at OTSWMS06-007 0001009 (stating WaMu filed a 12/12/2005 application to acquire Long Beach).
operations and allow it to strengthen Long Beach’s lending practices and risk management, as
well as reduce funding costs and administrative expenses.231 In addition, WaMu proposed that it
replace its current “Specialty Mortgage Finance” program, which involved purchasing subprime
loans for its portfolio primarily from Ameriquest, with a similar loan portfolio provided by Long
Beach.232 OTS had expressed a number of concerns about Long Beach in connection with the
purchase request,233 but in December 2005, after obtaining commitments from WaMu to
strengthen Long Beach’s lending and risk management practices, OTS agreed to the purchase.234
The actual purchase date was March 1, 2006.235
Immediately after the purchase in April 2006, after reviewing Long Beach’s
operations, WaMu President Rotella sent an email to WaMu CEO Killinger warning
about the extent of the problems: “[D]elinquencies are up 140% and foreclosures close to
70%. … First payment defaults are way up and the 2005 vintage is way up relative to
previous years. It is ugly.”236 Mr. Rotella, however, expressed hope that operations
would improve:
“Early changes by the new team from HL [Home Loans], who have deep
subprime experience, indicate a solid opportunity to mitigate some of this. I
would expect to see this emerge in 3 to 6 months. That said, much of the paper
we originated in the 05 growth spurt was low quality. … I have the utmost
confidence in the team overseeing this now and no doubt this unit will be more
productive and better controlled, but I figured you should know this is not a pretty
picture right now. We are all over it, but as we saw with repurchases, there was a
lot of junk coming in.”
Despite the new management and direct oversight by WaMu’s Home Loans Division,
Long Beach continued to perform poorly. Five months later, expected improvements had not
materialized. In September 2006, Mr. Rotella sent another email to Mr. Killinger stating that
Long Beach was still “terrible”:
“[Long Beach] is terrible, in fact negative right now. … We are being killed by the
lingering movement of EPDs [early payment defaults] and other credit related issues ….
[W]e are cleaning up a mess. Repurchases, EPDs, manual underwriting, very weak
servicing/collections practices and a weak staff. Other than that, well you get the
231 Id. at OTSWMS06-007 0001010.
232 Id. at OTSWMS06-007 0001011.
233 See, e.g., 6/3/2005 OTS internal memorandum by OTS examiner to OTS Deputy Regional Director, at
OTSWMS06-007 0002683, Hearing Exhibit 4/16-28.
234 See 12/21/2005 OTS memorandum, “Long Beach Mortgage Corporation (LBMC),” OTSWMS06-007 0001009,
Hearing Exhibit 4/16-31.
235 “Washington Mutual Regulators Timeline,” chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j.
236 4/27/2006 email from Steve Rotella to Kerry Killinger, JPM_WM05380911, Hearing Exhibit 4/13-11.
237 9/14/2006 WaMu internal email, Hearing Exhibit 4/13-12.
Again, he expressed hope that the situation would improve: “The good news is David and his
team are pros and are all over it.”238 Two months later, in November 2006, however, the head of
WaMu Capital Markets in New York, David Beck, relayed even more bad news to Mr.
Schneider, the Home Loans President: “LBMC [Long Beach] paper is among the worst
performing in the mkt [market] in 2006.”239
Despite the additional focus on improving its lending operations throughout 2006, Long
Beach was once again flooded with repurchase requests. According to a memorandum later
written by an FDIC examination specialist, “[d]uring 2006, more than 5,200 LBMC loans were
repurchased, totaling $875.3 million.”240 Even though, in January 2006, the bank had ceased
executing whole loan sales which allowed an automatic repurchase in the event of an EPD, 46%
of the repurchase volume was as a result of EPDs. Further, 43% of the repurchase volume
resulted from first payment defaults (FPDs) in which the borrower missed making the first
payment on the loan after it was sold.241 Another 10% of the repurchases resulted from
violations related to representation and warranties (R&W) not included in the EPD or FPD
numbers, meaning the violations were identified only later in the life of the loan.
R&W repurchases generally pose a challenge for a bank’s loss reserves, because the
potential liability—the repurchase request—continues for the life of the loan. The FDIC
memorandum observed:
“Management claims that R&W provisions are industry standard and indeed they may be.
However, I still found that the Mortgage Loan Purchase Agreement contains some
representations and warranties worth noting. For example, not only must the loans be
‘underwritten in accordance with the seller’s underwriting guideline,’ but the
‘origination, underwriting, and collection practices used by the seller with respect to each
mortgage loan have been in all material respects legal, proper, prudent, and customary in
the subprime mortgage business.’ This provision elevates the potential that investors can
put back a problem loan years after origination and not only must the loan have been
underwritten in line with bank guidelines but must also have been underwritten in
accordance with what is customary with other subprime lenders.”242
R&W repurchase requests and loss reserves continued to be an issue at Long Beach. The
fourth quarter of 2006 saw another spike in R&W repurchase requests, and in December the
required amount of R&W loss reserves jumped from $18 million to $76 million.243
238 Id.
239 11/7/2006 WaMu internal email, Hearing Exhibit 4/13-50.
240 See 6/5/2007 memorandum by Christopher Hovik, Examination Specialist, sent to FDIC Dedicated Examiner
Steve Funaro, “WaMu – Long Beach Mortgage Company (LMC) Repurchases,” at 1, FDIC_WAMU_000012348,
Hearing Exhibit 4/13-13b.
241 Id.
242 Id.
243 Id. at 3.
On December 22, 2006, the FDIC Dedicated Examiner at WaMu, Steve Funaro, sent an
email to Mr. Schneider, the Home Loans President, raising questions about the unexpected loan
defaults and repurchase demands. He wrote that Long Beach had the “[s]ame issues as FPD last
quarter … Current forecast of 35 to 50m [million] risk.” His email also noted potentially
insufficient loss reserves related to WaMu’s own subprime conduit that purchased subprime
loans from other lenders and mortgage brokers, some of which were going out of business and
would be unable to shoulder any liability for defaulting loans. His email noted forecasts of early
payment defaults totaling $15.6 million and loan delinquencies totaling $10.7 million, in addition
to other problems, and asked: “Why the miss? … Who is accountable?”244
Mr. Schneider forwarded the email to his team and expressed frustration at Long Beach’s
continuing problems:
“Short story is this is not good. … There is [a] growing potential issue around Long
Beach repurchases …. [W]e have a large potential risk from what appears to be a recent
increase in repurchase requests. … We are all rapidly losing credibility as a management
Performance in 2007 Worsens. The following year, 2007, was no better as the
performance of WaMu’s loan portfolio continued to deteriorate. WaMu’s chief risk officer, Ron
Cathcart, asked WaMu’s Corporate Credit Review team to assess the quality of Long Beach
loans and RMBS securities in light of the slowdown and decline in home prices in some areas.246
In January 2007, he forwarded an email with the results of the review, which identified “key risk
issues” related to recent loans and described deteriorating loan performance at Long Beach. The
“top five priority issues” were:
“Appraisal deficiencies that could impact value and were not addressed[;]
Material misrepresentations relating to credit evaluation were confirmed[;]
Legal documents were missing or contained errors or discrepancies[;]
Credit evaluation or loan decision errors[; and]
Required credit documentation was insufficient or missing from the file.”247
The review also found: “[D]eterioration was accelerating in recent vintages with each vintage
since 2002 having performed worse than the prior vintage.” Mr. Cathcart also expressed concern
that problems were not being reported to senior management. He wrote: “Long Beach
represents a real problem for WaMu. … I am concerned that Credit Review may seem to have
been standing on the sidelines while problems continue. For instance, why have Cathcart,
Schneider, Rotella and Killinger received NO report on any of this?”248
244 12/22/2006 email from Steve Funaro to David Schneider, Hearing Exhibit 4/13-13a.
245 12/2006 WaMu internal email, Hearing Exhibit 4/13-13a.
246 12/7/2006 email from Ron Cathcart to his colleagues, Hearing Exhibit 4/13-15.
247 1/2/2007 email from Ron Cathcart to Cory Gunderson, Hearing Exhibit 4/13-16.
248 Id.
In February 2007, WaMu senior managers discussed “how best to dispose” of $433
million in Long Beach performing second lien loans, due to “disarray” in the securitization
market.249 David Beck, head of WaMu’s Wall Street operation, wrote that securitizing the loans
was “not a viable exit strategy” and noted:
“Investors are suffering greater than expected losses from subprime in general as well as
subprime 2nd lien transactions. As you know, they are challenging our underwriting
representations and warrants. Long Beach was able to securitize 2nd liens once in 2006
in May. We sold the BBB- bonds to investors at Libor +260. To date, that transaction
has already experienced 7% foreclosures.”250
WaMu CEO Killinger complained privately to President Steve Rotella:
“Is this basically saying that we are going to lose 15 [percent] on over $400 million of
this product or 60 million. That is a pretty bad hit that reflects poorly on credit and others
responsibility for buying this stuff. Is this showing up in hits to compensation or
personnel changes.”251
WaMu President Rotella responded:
“This is second lien product originated 7-10 months ago from Long Beach. … In 2006
Beck’s team started sprinkling seconds in deals as they could. And, we now have the %
down to the low single digits, so that we can sell all into our deals (assuming the market
doesn’t get even worse).”
He continued: “In terms of folks losing their jobs, the people largely responsible for bringing us
this stuff are gone, the senior management of LB.”252
Also in February 2007, early payment defaults again ticked up. A review of the first
quarter of 2007 found: “First payment defaults (FPDs) rose to 1.96% in March but are projected
to fall back to 1.87% in April based on payments received through May 5th.”253 It also reported
that the findings from a “deep dive into February FPDs revealed” that many of the problems
could have been eliminated had existing guidelines been followed:
“The root cause of over 70% of FPDs involved operational issues such as missed fraud
flags, underwriting errors, and condition clearing errors. This finding indicates there may
be opportunities to improve performance without further restricting underwriting
249 2/2007 email chain among WaMu personnel, JPM_WM00673101-03, Hearing Exhibit 4/13-17.
250 Id. at JPM_WM00673103.
251 Id. at JPM_WM00673101.
252 Id.
253 “Quarterly Credit Risk Review SubPrime,” prepared by WaMu Home Loans Risk Management (1st Quarter,
2007), Hearing Exhibit 4/13-18.
254 Id.
In June 2007, WaMu decided to discontinue Long Beach as a separate entity, and instead
placed its subprime lending operations in a new WaMu division called “Wholesale Specialty
Lending.” That division continued to purchase subprime loans and issue subprime
Some months later, an internal WaMu review assessed “the effectiveness of the action
plans developed and implemented by Home Loans to address” the first payment default problem
in the Wholesale Specialty Lending division.255 After reviewing 187 FPD loans from November
2006 through March 2007, the review found:
“The overall system of credit risk management activities and process has major
weaknesses resulting in unacceptable level of credit risk. Exposure is considerable and
immediate corrective action is essential in order to limit or avoid considerable losses,
reputation damage, or financial statement errors.”256
In particular, the review found:
“Ineffectiveness of fraud detection tools – 132 of the 187 (71%) files were reviewed …
for fraud. [The review] confirmed fraud on 115 [and 17 were] … ‘highly suspect’. ...
Credit weakness and underwriting deficiencies is a repeat finding …. 80 of the 112
(71%) stated income loans were identified for lack of reasonableness of income[.] 133
(71%) had credit evaluation or loan decision errors …. 58 (31%) had appraisal
discrepancies or issues that raised concerns that the value was not supported.”257
July 2007 was a critical moment not only for WaMu, but also for the broader market for
mortgage securities. In that month, Moody’s and S&P downgraded the ratings of hundreds of
RMBS and CDO securities, including 40 Long Beach subprime securities.258 The mass
downgrades caused many investors to immediately stop buying subprime RMBS securities, and
the securities plummeted in value. Wall Street firms were increasingly unable to find investors
for new subprime RMBS securitizations.
In August 2007, WaMu’s internal audit department released a lengthy audit report
criticizing Long Beach’s poor loan origination and underwriting practices.259 By that
time, Long Beach had been rebranded as WaMu’s Wholesale Specialty Lending division,
the subprime market had collapsed, and subprime loans were no longer marketable. The
audit report nevertheless provided a detailed and negative review of its operations:
255 9/28/2007 “Wholesale Specialty Lending-FPD,” WaMu Corporate Credit Review, JPM_WM04013925, Hearing
Exhibit 4/13-21.
256 Id. at 2.
257 Id. at 3.
258 7/10/2007-7/12/2007 excerpts from Standard & Poor’s and Moody’s Downgrades, Hearing Exhibit 4/23-99.
259 8/20/2007 “Long Beach Mortgage Loan Origination & Underwriting,” WaMu audit report, JPM_WM02548939,
Hearing Exhibit 4/13-19
“[T]he overall system of risk management and internal controls has deficiencies related to
multiple, critical origination and underwriting processes .… These deficiencies require
immediate effective corrective action to limit continued exposure to losses. … Repeat
Issue – Underwriting guidelines established to mitigate the risk of unsound underwriting
decisions are not always followed …. Improvements in controls designed to ensure
adherence to Exception Oversight Policy and Procedures is required …. [A]ccurate
reporting and tracking of exceptions to policy does not exist.”260
In response, Mr. Rotella wrote to WaMu’s General Auditor: “This seems to me to be the
ultimate in bayonetting the wounded, if not the dead.”261
Subprime Lending Ends. In September 2007, with investors no longer interested in
buying subprime loans or securitizations, WaMu shut down all of its subprime operations.262
During the prior year, which was their peak, Long Beach and WaMu had securitized $29 billion
in subprime loans; by 2007, due to the collapse of the subprime secondary market, WaMu’s
volume for the year dropped to $5.5 billion. Altogether, from 2000 to 2007, Long Beach and
WaMu had securitized at least $77 billion in subprime loans.263
When asked about Long Beach at the Subcommittee’s hearing, all of the WaMu former
managers who testified remembered its operations as being problematic, and could not explain
why WaMu failed to strengthen its operations. Mr. Vanasek, former Chief Risk Officer, testified
that Long Beach did not have an effective risk management regime when he arrived at WaMu in
1999, and that it had not developed an effective risk management regime by the time he retired at
the end of 2005.264 Likewise, Mr. Cathcart, who replaced Mr. Vanasek as Chief Risk Officer,
testified that Long Beach never developed effective risk management during the course of his
At the April 13 Subcommittee hearing, Senator Levin asked Mr. Vanasek: “Is it fair to
say that WaMu is not particularly worried about the risk associated with Long Beach subprime
mortgages because it sold those loans and passed the risk on to investors?” Mr. Vanasek replied:
“Yes, I would say that was a fair characterization.”266
Home Loans President David Schneider, who had direct responsibility for addressing the
problems at Long Beach, testified that he tried to improve Long Beach, but “ultimately decided
… Long Beach was an operation that we should shut down.”267
260 Id. at JPM_WM02548940-41.
WaMu President Steve Rotella
also acknowledged the inability of WaMu management to resolve the problems at Long Beach:
261 8/21/2007 email from Steve Rotella to Randy Melby, JPM_WM04859837, Hearing Exhibit 4/13-20.
262 “Washington Mutual Regulators Timeline,” chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j.
263 “Securitizations of Washington Mutual Subprime Home Loans,” chart prepared by the Subcommittee, Hearing
Exhibit 4/13-1c.
264 April 13, 2010 Subcommittee Hearing at 22.
265 Id. at 22.
266 Id. at 23.
267 Id. at 55.
“We did bring the volume in Long Beach down substantially every quarter starting in the
first quarter of 2006. As we went through that process, it became increasingly clear, as I
have indicated in here, that the problems in Long Beach were deep and the only way we
could address those were to continue to cut back volume and ultimately shut it down.”268
Community Impact. Long Beach’s poor quality loans not only proved unprofitable for
many investors, they were often devastating for the borrowers and their communities. Mr.
Killinger testified at the Subcommittee hearing that WaMu, “entered the subprime business with
our purchase of Long Beach Mortgage in 1999 to better serve an underserved market.”269 But
the unfortunate result of many Long Beach loans was that they left communities reeling from
widespread foreclosures and lost homes.
In November 2008, the Office of the Comptroller of the Currency (OCC) which oversees
all nationally chartered banks, identified the ten metropolitan areas across the United States with
the highest rates of foreclosure for subprime and Alt A mortgages originated from 2005 through
2007.270 Those ten areas were, in order: Detroit, Cleveland, Stockton, Sacramento,
Riverside/San Bernardino, Memphis, Miami/Fort Lauderdale, Bakersfield, Denver, and Las
Vegas. The OCC then identified the lenders with the highest foreclosure rates in each of those
devastated cities. Long Beach had the worst foreclosure rate in four of those areas, and was near
the worst in five more, with the lone exception being Las Vegas. The OCC data also showed
that, overall in the ten metropolitan areas, Long Beach mortgages had the second worst
foreclosure rate of all the lenders reviewed, with over 11,700 foreclosures at the time of the
report. Only New Century was worse.
(2) WaMu Retail Lending
Washington Mutual’s problems were not confined to its subprime operations; they also
affected its retail operations. WaMu loosened underwriting standards as part of its High Risk
Lending Strategy, and received repeated criticisms from its regulators, as outlined in the next
chapter, for weak underwriting standards, risk layering, excessive loan error and exception rates,
appraisal problems, and loan fraud. In August of 2007, more than a year before the collapse of
the bank, WaMu’s President Steve Rotella emailed CEO Kerry Killinger saying that, aside from
Long Beach, WaMu’s prime home loan business “was the worst managed business I had seen in
my career.”271
(a) Inadequate Systems and Weak Oversight
One reason for WaMu’s poor lending practices was its failure to adequately monitor the
hundreds of billions of dollars of residential loans being issued each year by its own loan
268 Id. at 90.
269 Id. at 86.
270 11/13/2008 “Worst Ten in the Worst Ten,” document prepared by the Office of the Comptroller of the Currency,, Hearing Exhibit 4/13-58.
271 8/23/2007 email from Mr. Rotella to Mr. Killinger, JPM_WM00675851, Hearing Exhibit 4/13-79.
personnel. From 1990 until 2002, WaMu acquired more than 20 new banks and mortgage
companies, including American Savings Bank, Great Western Bank, Fleet Mortgage
Corporation, Dime Bancorp, PNC Mortgage, and Long Beach. WaMu struggled to integrate
dozens of lending platforms, information technology systems, staffs, and policies, whose
inconsistencies and gaps exposed the bank to loan errors and fraud.
To address the problem, WaMu invested millions of dollars in a technology program
called Optis, which WaMu President Rotella described in the end as “a complete failure” that the
bank “had to write off” and abandon.272 In 2004, an OTS Report of Examination (ROE), which
was given to the bank’s Board of Directors, included this observation:
“Our review disclosed that past rapid growth through acquisition and unprecedented
mortgage refinance activity placed significant operational strain on [Washington Mutual]
during the early part of the review period. Beginning in the second half of 2003, market
conditions deteriorated, and the failure of [Washington Mutual] to fully integrate past
mortgage banking acquisitions, address operational issues, and realize expectations from
certain major IT initiatives exposed the institution’s infrastructure weaknesses and began
to negatively impact operating results.”273
The records reviewed by the Subcommittee showed that, from 2004 until its shuttering in 2008,
WaMu constantly struggled with information technology issues that limited its ability to monitor
loan errors, exception rates, and indicators of loan fraud.
From 2004 to 2008, WaMu’s regulators also repeatedly criticized WaMu’s failure to
exercise sufficient oversight of its loan personnel to reduce excessive loan error and exception
rates that allowed the issuance of loans in violation of WaMu’s credit standards.274 In 2004,
Craig Chapman, then the President of WaMu Home Loans, visited a number of the bank’s loan
centers around the country. Lawrence Carter, then OTS Examiner-in-Charge at WaMu, spoke
with Mr. Chapman about what he found. Recalling that conversation in a later email, Mr. Carter
“Craig has been going around the country visiting home lending and fulfillment offices.
His view is that band-aids have been used to address past issues and that there is a
fundamental absence of process.”275
The regulators’ examination reports on WaMu indicate that its oversight efforts remained
weak. In February 2005, OTS stated that WaMu’s loan underwriting “has been an area of
272 Subcommittee interview of Steve Rotella (2/24/2010).
273 See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001482, Hearing Exhibit 4/16-94 [Sealed
Exhibit]. See also, e.g., 12/17/2004 email exchange among WaMu executives, “Risks/Costs to Moving GSE Share
to FH,” JPM_WM05501400, Hearing Exhibit 4/16-88 (noting that Fannie Mae “is well aware of our data integrity
issues (miscoding which results in misdeliveries, expensive and time consuming data reconciliations), and has been
exceedingly patient.”).
274 See, e.g., OTS examination reports cited in Chapter IV, below.
275 8/13/2004 email from Lawrence Carter to Michal Finn, Finn_Michael-00005331.
concern for several exams.”276 In June 2005, OTS expressed concern about the bank’s
underwriting exceptions and policy compliance.277 In August of the same year, the OTS Report
of Examination stated that, “the level of deficiencies, if left unchecked, could erode the credit
quality of the portfolio,” and specifically drew attention to WaMu concentrations in higher risk
loans that were a direct result of its High Risk Lending Strategy.278 2006 was no better. OTS
repeatedly criticized the level of underwriting exceptions and errors.279
Another problem was the weak role played by WaMu’s compliance department. In
March 2007, an OTS examiner noted that WaMu had just hired its “ninth compliance leader
since 2000,” and that its “compliance management program has suffered from a lack of steady,
consistent leadership.” The examiner added: “The Board of Directors should commission an
evaluation of why smart, successful, effective managers can’t succeed in this position. …
(HINT: It has to do with top management not buying into the importance of compliance and turf
warfare and Kerry [Killinger] not liking bad news.)”280
Still another problem was that WaMu failed to devote sufficient resources to overseeing
the many loans it acquired from third party lenders and mortgage brokers. The 2010 Treasury
and FDIC IG report found that, from 2003 to 2007, a substantial portion of WaMu’s residential
loans—from 48% to 70%—came from third party lenders and brokers.281 The IG report also
“The financial incentive to use wholesale loan channels for production was significant.
According to an April 2006 internal presentation to the WaMu Board, it cost WaMu
about 66 percent less to close a wholesale loan ($1,809 per loan) than it did to close a
retail loan ($5,273). Thus, WaMu was able to reduce its cost of operations through the
use of third-party originators but had far less oversight over the quality of
During its last five years, WaMu accepted loans from tens of thousands of third party
brokers and lenders across the country, not only through its wholesale and correspondent
channels, but also through its securitization conduits that bought Alt A and subprime loans in
bulk. Evidence gathered by the Subcommittee from OTS examination reports, WaMu internal
276 2/7/2005 OTS Letter to Washington Mutual Board of Directors on Matters Requiring Board Attention,
OTSWMEF-0000047591, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See the Regulator Chapter of this Report for
more information.
277 6/3/2005 OTS Findings Memorandum, “Single Family Residential Home Loan review,” OTSWME05-004
0000392, Hearing Exhibit 4/16-26. For more information, see Chapter IV, below.
278 3/14/2005 OTS Report of Examination, OTSWMS05-004 0001794, Hearing Exhibit 4/16-94 [Sealed Exhibit].
(Examination findings were issued to WaMu on August 28, 2005.)
279 See, for example, 5/23/2006 OTS Exam Finding Memo, “Home Loan Underwriting, “ OTSWMS06-008
0001299, Hearing Exhibit 4/16-33; and 8/29/2006 OTS Report of Examination, OTSWMS06-008 0001690, Hearing
Exhibit 4/16-94 [Sealed Exhibit].
280 5/31/2007 Draft OTS Findings Memorandum, “Compliance Management Program,” Franklin_Benjamin-
00020408_001, Hearing Exhibit 4/16-9.
281 4/2010 IG Report, at 23, Hearing Exhibit 4/16-82.
282 Id. at 23.
documents, and oral testimony shows that WaMu exercised weak oversight over the thousands of
brokers submitting loans. For example, a 2003 OTS report concluded that WaMu’s “annual
review and monitoring process for wholesale mortgage brokers was inadequate, as management
did not consider key performance indicators such as delinquency rates and fraud incidents.”283 A
2003 WaMu quality assurance review found an “error rate of 29 percent for wholesale mortgage
loans, more than triple the acceptable error rate of 8 percent established by WaMu.”284 A 2004
OTS examination noted that 20,000 brokers and lenders had submitted loans to WaMu for
approval during the year, a volume that was “challenging to manage.”285 A 2005 internal WaMu
investigation of two high volume loan centers in Southern California that accepted loans from
brokers found that “78% of the funded retail broker loans reviewed were found to contain
fraud.”286 A 2006 internal WaMu inquiry into why loans purchased through its subprime
conduit were experiencing high delinquency rates found the bank had securitized broker loans
that were delinquent, not underwritten to standards, and suffering from “lower credit quality.”287
OTS examinations in 2006 and 2007 also identified deficiencies in WaMu’s oversight
efforts.288 For example, a 2007 OTS memorandum found that, in 2007, Washington Mutual had
only 14 full-time employees overseeing more than 34,000 third party brokers submitting loans to
the bank for approval,289 which meant that each WaMu employee oversaw more than 2,400
brokers. The OTS examination not only questioned the staffing level, but also criticized the
scorecard WaMu used to rate the mortgage brokers, which did not include the rates at which
significant lending or documentation deficiencies were attributed to the broker, the rate at which
the broker’s loans were denied or produced unsaleable loans, or any indication of whether the
broker was included on industry watch lists for prior or suspected misconduct.
In 2006, federal regulators issued Interagency Guidance on Nontraditional Mortgage
Product Risks (NTM Guidance) providing standards on how banks “can offer nontraditional
mortgage products in a safe and sound manner.”290 It focused, in part, on the need for banks to
“have strong systems and controls in place for establishing and maintaining relationships” with
third party lenders and brokers submitting high risk loans for approval. It instructed banks to
monitor the quality of the submitted loans to detect problems such as “early payment defaults,
incomplete documentation, and fraud.” If problems arose, the NTM Guidance directed banks to
“take immediate action”:
283 Id.
284 Id. at 24.
285 Id.
286 11/16/2005 “Retail Fraud Risk Overview,” prepared by WaMu Credit Risk Management, at JPM_WM02481938,
Hearing Exhibit 4/13-22b.
287 12/12/2006 WaMu Market Risk Committee Minutes, JPM_WM02095545, Hearing Exhibit 4/13-28.
288 4/2010 IG Report, at 24-25, Hearing Exhibit 4/16-82.
289 6/7/2007 OTS Asset Quality Memo 11, “Broker Credit Administration,” Hedger_Ann-00027930_001, Hearing
Exhibit 4/16-10.
290 10/4/2006 “Interagency Guidance on Nontraditional Mortgage Product Risks,” (NTM Guidance), 71 Fed. Reg.
192 at 58609.
“Oversight of third party brokers and correspondents who originate nontraditional
mortgage loans should involve monitoring the quality of originations so that they reflect
the institution’s lending standards and compliance with applicable laws and regulations.
… If appraisal, loan documentation, credit problems or consumer complaints are
discovered, the institution should take immediate action.”291
WaMu did, at times, exercise oversight of its third party brokers. A 2006 credit review of
its subprime loans, for example, showed that Long Beach—which by then reported to the WaMu
Home Loans Division—had terminated relationships with ten brokers in 2006, primarily because
their loans had experienced high rates of first payment defaults requiring Long Beach to
repurchase them at significant expense.292 But terminating those ten brokers was not enough to
cure the many problems with the third party loans WaMu acquired. The report also noted that, in
2006, apparently for the first time, Long Beach had introduced “collateral and broker risk” into
its underwriting process.293
WaMu closed down its wholesale and subprime channels in 2007, and its Alt A and
subprime securitization conduits in 2008.
(b) Risk Layering
During the five-year period reviewed by the Subcommittee, from 2004 to 2008, WaMu
issued many loans with multiple higher risk features, a practice known as “risk layering.” At the
April 13 Subcommittee hearing, Mr. Vanasek, its Chief Risk Officer from 2004 to 2005, testified
about the dangers of this practice:
“It was the layering of risk brought about by these incremental changes that so altered the
underlying credit quality of mortgage lending which became painfully evident once
housing prices peaked and began to decline. Some may characterize the events that took
place as a ‘perfect storm,’ but I would describe it as an inevitable consequence of
consistently adding risk to the portfolio in a period of inflated housing price
Stated Income Loans. One common risk layering practice at WaMu was to allow
borrowers to “state” the amount of their annual income in their loan applications without any
direct documentation or verification by the bank. Data compiled by the Treasury and the FDIC
IG report showed that, by the end of 2007, 50% of WaMu’s subprime loans, 73% of its Option
ARMs, and 90% of its home equity loans were stated income loans.295
291 Id. at 58615.
The bank’s acceptance of
unverified income information came on top of its use of loans with other high risk features, such
292 12/2006 “Home Loans – SubPrime Quarterly Credit Risk Review,” JPM_WM04107374, Hearing Exhibit 4/13-
293 Id. at JPM_WM04107375.
294 April 13, 2010 Subcommittee Hearing at 16.
295 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82.
as borrowers with low credit scores or the use of low initial teaser interest rates followed by
much higher rates.
Stated income loans were originally developed to assist self employed individuals that
had good credit and high net worth to obtain loans they could afford. But from 2004 to 2008,
stated income loans became much more widespread, including with respect to a wide variety of
high risk loans.296 Mr. Cathcart testified at the Subcommittee hearing:
“[Stated income loans] originated as a product for self-employed individuals who didn’t
have pay stubs and whose financial statements didn’t necessarily reflect what they made.
It was intended to be available for only the most creditworthy borrowers and it was
supposed to be tested for reasonableness so that a person who said that they were a waiter
or a lower-paid individual couldn’t say that they had an income of $100,000.
“I think that the standards eroded over time. At least I have become aware, reading all
that has happened … standards eroded over time and that it became a competitive tool
that was used by banks to gather business, so that if a loan consultant could send his loan
to Bank A or Bank B, the consultant would say, well, why don’t you go to Bank B? You
don’t have to state your income.
“I do think, thinking it through, that there was a certain amount of coaxing that was
possible between the loan consultant and the individual, which would be something
which would be invisible to a bank that received the application and the only test for that
would be reasonableness, which as you have heard there were some issues within the
WaMu required its loan personnel to determine whether a loan applicant’s stated income
was reasonable, but evidence obtained by the Subcommittee indicates that requirement was not
effectively implemented. A 2008 press report about a WaMu stated income loan is illustrative:
“As a supervisor at a Washington Mutual mortgage processing center, John D. Parsons
was accustomed to seeing baby sitters claiming salaries worthy of college presidents, and
schoolteachers with incomes rivaling stockbrokers. He rarely questioned them. A real
estate frenzy was under way and WaMu, as his bank was known, was all about saying
“Yet even by WaMu’s relaxed standards, one mortgage four years ago raised eyebrows.
The borrower was claiming a six-figure income and an unusual profession: mariachi
296 See, e.g., NTM Guidance at 58614 (“Institutions increasingly rely on reduced documentation, particularly
unverified income, to qualify borrowers for nontraditional mortgage loans.”). The NTM Guidance directed banks to
use stated income loans “with caution,” but did not prohibit them or even issue guidance limiting their use. Id. at
58611, 58614.
297 April 13, 2010 Subcommittee Hearing at 41.
“Mr. Parsons could not verify the singer’s income, so he had him photographed in front
of his home dressed in his mariachi outfit. The photo went into a WaMu file.
Instead of verifying borrower income, WaMu loan personnel apparently focused instead
on borrower credit scores, as a proxy measure of a borrower’s creditworthiness. The problem
with this approach, however, was that a person could have a high credit score—reflecting the
fact that they paid their bills on time—and still have an income that was insufficient to support
the mortgage amount being requested.
High LTV Ratios. A second risk-layering practice at WaMu involved loan-to-value
(LTV) ratios. LTV ratios are a critical risk management tool, because they compare the loan
amount to the estimated dollar value of the property. If an LTV ratio is too high and the
borrower defaults, the sale of the property may not produce sufficient proceeds to pay off the
loan. In interagency guidance, federal banking regulators noted that banks should generally
avoid issuing loans with LTV ratios over 80%, and directed banks to ensure that loans with LTV
ratios of 90% or more have additional credit support such as mortgage insurance or added
collateral.299 The Treasury and the FDIC IG report found that WaMu held a “significant
percentage” of home loans in which the LTV ratios exceeded 80%.300
These loans were the result of explicit WaMu policies allowing high LTV ratios to be
used in loans that already had other high risk features. In February 2005, for example, WaMu set
up automated loan approval parameters to approve loans with a 90% LTV in Option ARM and
interest-only loans providing financing of up to $1 million.301 Still another layer of risk was
added to these loans by permitting the borrowers to have credit scores as low as 620.
The Treasury and the FDIC IG report determined that 44% of WaMu’s subprime loans
and 35% of its home equity loans had LTV ratios in excess of 80%.302 These loans resulted in
part from a 2006 WaMu decision to combine home equity loans bearing high LTV ratios with
borrowers bearing low credit scores. That initiative was discussed in a June 2006 email sent to
Mr. Rotella, after he inquired about the project. He was informed:
298 “Saying Yes, WaMu Built Empire on Shaky Loans,” New York Times (12/27/08). When asked about this press
report, WaMu told the Subcommittee that it had no record of this loan, but could not deny that the incident took
place as reported. See also, in the following subsection, a WaMu loan issued to a “Sign Designer” who claimed
earnings of $34,000 per month.
299 See 10/8/1999 “Interagency Guidance on High LTV Residential Real Estate Lending,”
300 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82.
301 2/2005 email chain between Timothy Bates, Tony Meola, Mr. Rotella and others, JPM_WM00616783-84.
302 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. See also 3/1/2007 Washington Mutual Inc. 10-K filing with
the SEC, at 52 (showing that, as of 12/31/2006, WaMu held $7.4 billion in home mortgages without private
mortgage insurance or government guarantees with LTV ratios in excess of 80%, and $15 billion in home equity
loans and lines of credit with LTV ratios in excess of 80%).
“$4 billion home equity investment program [was] approved … last Friday. High CLTVs
[Combined Loan-to-Value ratios] (up to 100%) and lower FICOs (down to 600)
permitted with some concentration limits.”303
In order to issue these loans as soon as possible in 2006, WaMu set up an underwriting team to
provide “manual” approvals outside of its automated systems:
“Our team is currently focused on several HE [Home Equity] modeling initiatives to
include higher risk lending …. [W]e are adjusting our decision engine rules for a July
roll out to allow for 580-620 [FICO scores] and LT 80% CLTV [combined loan-to-value]
loans to be referred to a manual ‘sub-prime’ underwriting team that we are putting in
place. … [W]e see this 580-620 segment as the biggest opportunity where we aren’t
lending today.”304
Also in 2006, WaMu began issuing so-called “80/20 loans,” in which a package of two
loans are issued together, imposing an 80% LTV first lien and a 20% LTV second lien on the
property, for a total combined LTV (CLTV) of 100%.305 Loans that provide financing for 100%
of a property’s value are extremely high risk, because the borrower has no equity in the property,
the borrower can stop payments on the loan without losing a personal investment, and a
subsequent home sale may not produce sufficient funds to pay off the debt.306 Yet in 2006,
Home Loans Division President David Schneider approved issuing 80/20 loans despite the risk
and despite the fact that WaMu’s automatic underwriting system was not equipped to accept
them, and loan officers initially had to use a manual system to issue the loans.307
Using Low Interest Rates to Qualify Borrowers. A third risk layering practice at
WaMu was allowing loan officers to qualify prospective borrowers for short term hybrid ARMs
or Option ARMs based upon only the initial low rate and not the higher interest rate that would
take effect later on. In a filing with the SEC, for example, Washington Mutual Inc. wrote that its
“underwriting guidelines” allowed “borrowers with hybrid adjustable-rate home loans … where
the initial interest rate is fixed for 2 to 5 years” to be “qualified at the payment associated with
the fixed interest rate charged in the initial contractual period.”308
303 6/13/2006 email from Cheryl Feltgen to David Schneider who forwarded it to Steve Rotella,
In addition, in 2005, WaMu
personnel informed OTS that, since 2004, the bank had not been qualifying its Option ARM
304 6/14/2006 email from Mark Hillis to Cheryl Feltgen, included in a longer email chain involving Mr. Rotella and
Mr. Schneider, among others, JPM_WM01311922.
305 See, e.g., 6/2006 email chain between Mr. Rotella, Mr. Schneider, Mr. Hillis, and Ms. Feltgen,
306 See NTM Guidance at 58614. See also SEC v. Mozilo, Case No. CV09-03994 (USDC CD Calif.), Complaint
(June 4, 2009), at ¶ 50 (quoting an email by Countrywide CEO Angelo Mozilo who, when discussing the 80/20
loans being issued by his bank, wrote: “In all my years in the business I have never seen a more toxic pr[o]duct.”).
307 Id.; Subcommittee interview of Cheryl Feltgen (2/6/2010). 2/2006 WaMu internal email chain, “FW: 80/20,”
JPM_WM03960778. See also 3/19/2007 email from Ron Cathcart to David Schneider, JPM_WM02571598,
Hearing Exhibit 4/16-75 (indicating WaMu issued loans with CLTVs in excess of 95% until ending the practice in
March 2007).
308 See 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC at 56.
borrowers using the “fully indexed rate.”309 Instead, WaMu was using a lower “administrative”
rate that was “significantly less than the fully indexed rate.”310
Borrowers, loan officers, and WaMu executives often assumed that hybrid and Option
ARMs could be refinanced before the payments reset to higher levels—an expectation that
eventually proved to be unfounded. In a November 30, 2007 email discussing loan
modifications from Mr. Schneider to Mr. Killinger, Mr. Rotella and other senior executives, Mr.
Schneider described WaMu’s faulty assumptions about the “start rate” and life span of these
“I also think it is clear that the economic benefit of providing modifications for these
borrowers is compelling for the following reasons:
- None of these borrowers ever expected that they would have to pay at a rate
greater than the start rate. In fact, for the most part they were qualified at the start
- We need to provide incentive to these borrowers to maintain the home –
especially if the home value has declined
- When we booked these loans, we anticipated an average life of 2 years and
never really anticipated the rate adjustments….”311
Qualifying borrowers using the lower initial interest rate enabled banks to qualify more
borrowers for those loans and enabled them to issue loans for larger amounts. Concerned that
more banks were beginning to use this risky practice, federal banking regulators addressed it in
the October 2006 NTM Guidance, which cautioned banks to use the fully indexed rate when
qualifying borrowers for a loan, including loans with lower initial teaser rates.312 In addition, the
Guidance provided that for negatively amortizing loans, banks should consider not only the
“initial loan amount” but also “any balance increase that may accrue from the negative
amortization provision.”313 After the NTM Guidance was issued, a WaMu analyst calculated
that applying the new requirement to all of its loans would cause a 33% drop in its loan volume
due to borrowers who would no longer qualify for its loans:
“Implementing the NTM change for Purchase only drops additional 2.5% of volume … If
we implement the NTM changes to all loans, then we’ll see additional drop of 33% of
309 9/15/2005 email from Darrel Dochow to OTS Examiner-In-Charge at WaMu, OTSWMS05-002 0000537,
Hearing Exhibit 4/16-6. The “fully indexed rate” is the prevailing interest rate in the published index to which an
adjustable rate mortgage is tied, plus the additional percentage points that the lender adds to the index value to
calculate the loan’s interest rate. See NTM Guidance at 58614, n.5.
310 Id.
311 11/30/2007 email from David Schneider to John McMurray, Kerry Killinger and others, JPM_WM05382127-28.
312 NTM Guidance at 58614.
313 Id.
314 3/19/2007 email from Ron Cathcart to David Schneider, JPM_WM02571598, Hearing Exhibit 4/16-75.
In response to this information, WaMu’s chief risk officer wrote that the impact on the bank
“argues in favor of holding off on implementation until required to act for public relations … or
regulatory reasons.”
Because OTS gave the bank more than six months to come into compliance with the
NTM Guidance, WaMu continued qualifying high risk borrowers using the lower interest rate,
originating billions of dollars in new loans that would later suffer significant losses.
WaMu’s risk-layering practices went beyond its use of stated income loans, high LTV
ratios, and the qualification of borrowers using low initial interest rates. The bank also allowed
its loan officers to issue large volumes of high risk loans to borrowers who did not occupy the
homes they were purchasing or had large debt-to-income ratios.315 On top of those risks, WaMu
concentrated its loans in a small number of states, especially California and Florida, increasing
the risk that a downturn in those states would have a disproportionate impact upon the
delinquency rates of its already high risk loans.
At one point in 2004, Mr. Vanasek made a direct appeal to WaMu CEO Killinger, urging
him to scale back the high risk lending practices that were beginning to dominate not only
WaMu, but the U.S. mortgage market as a whole. Despite his efforts, he received no response:
“As the market deteriorated, in 2004, I went to the Chairman and CEO with a proposal
and a very strong personal appeal to publish a full-page ad in the Wall Street Journal
disavowing many of the then-current industry underwriting practices, such as 100 percent
loan-to-value subprime loans, and thereby adopt what I termed responsible lending
practices. I acknowledged that in so doing the company would give up a degree of
market share and lose some of the originators to the competition, but I believed that
Washington Mutual needed to take an industry-leading position against deteriorating
underwriting standards and products that were not in the best interests of the industry, the
bank, or the consumers. There was, unfortunately, never any further discussion or
response to the recommendation.”316
(c) Loan Fraud
Perhaps the clearest evidence of WaMu’s shoddy lending practices came when senior
management was informed of loans containing fraudulent information, but then did little to stop
the fraud.
315 See, e.g., OTS document, “Hybrid ARM Lending Survey” (regarding WaMu), undated but the OTS Examiner-in-
Charge estimated it was prepared in March or mid-2007, JPM_WM03190673 (“For Subprime currently up to 100%
LTV/CLTV with 50% DTI is allowed for full Doc depending on FICO score. Up to 95% LTV/CLTV is allowed
with 50% DTI for Stated Doc depending on FICO score. … For No Income Verification, No Income No Ratio, and
No Income No Asset only up to 95% LTV/CLTV is allowed.”).
316 April 13, 2010 Subcommittee Hearing at 17.
Downey and Montebello Fraud Investigations. The most significant example involves
an internal WaMu investigation that, in 2005, uncovered substantial evidence of loan fraud
involving two top producing loan offices in Southern California. WaMu management was
presented with the findings, but failed to respond, leading to the same fraud allegations erupting
again in 2007. According to the WaMu Home Loans Credit Risk Mitigation Team that
conducted the 2005 internal investigation, it was initiated in response to “a sustained history of
confirmed fraud findings over the past three years” involving the two offices, known as Downey
and Montebello.317 Each office was located in a low-income area of Los Angeles and headed by
a loan officer who had won repeated WaMu awards for high volume loan production.
To conduct its inquiry, the WaMu Risk Mitigation Team reviewed all of the loans
produced by the two offices over a two-month period from August to September 2005, which
totaled 751 loans. Analysts scored the loans using a standard electronic fraud detection program,
and then reviewed all of the loans flagged for possible fraud, as well as ten percent of the
remaining loans.318 A November 2005 memorandum summarizing the review stated that it
found an “extensive level of loan fraud” caused primarily by employees circumventing bank
“[A]n extensive level of loan fraud exists in the Emerging Markets [loan processing
centers], virtually all of it stemming from employees in these areas circumventing bank
policy surrounding loan verification and review. Of the 129 detailed loan review[s] …
conducted to date, 42% of the loans reviewed contained suspect activity or fraud,
virtually all of it attributable to some sort of employee malfeasance or failure to execute
company policy. In terms of employee activity enabling this perpetration of fraud, the
following categories of activity appeared most frequently: inconsistent application of
credit policy, errors or negligence, process design flaws, intentional circumvention of
established processes, and overriding automated decisioning recommendations. …
Based on the consistent and pervasive pattern of activity among these employees, we are
recommending firm action be taken to address these particular willful behaviors on the
part of the employees named.”319
A presentation prepared for WaMu management provided additional detail.320 It stated
that, out of the 751 loans produced, the Risk Mitigation Team had selected 180 loans for detailed
review, of which 129 had been completed.321 It stated that 42% of the reviewed loans had
“contained excessive levels of fraud related to loan qualifying data.”322
317 11/17/2005 WaMu internal memorandum, “So. CA Emerging Markets Targeted Loan Review Results,”
JPM_WM01083051, Hearing Exhibit 4/13-22a.
It also stated that the
fraud findings did not differ between loans originated by WaMu’s own loan officers and loans
318 Id.
319 Id.
320 11/16/2005 “Retail Fraud Risk Overview,” prepared by Credit Risk Management, JPM_WM02481934, Hearing
Exhibit 4/13-22b.
321 Id. at JPM_WM02481940.
322 Id. at JPM_WM02481936.
originated by third party brokers and brought to the loan centers.323 The presentation also stated
that the fraud uncovered by the review was found to be “preventable with improved processes
and controls.”
The presentation indicated that the loan fraud involved primarily “misrepresentation of
loan qualifying data,” including misrepresentations of income and employment, false credit
letters and appraisal issues.324 The presentation included a few examples of misrepresentations,
“Loan #0694256827[:] Misrepresentation [of] the borrower’s identification and
qualifying information were confirmed in every aspect of this file, including: – Income –
SSN – Assets – Alternative credit reference letters – Possible Strawbuyer or Fictitious
borrower[.] The credit package was found to be completely fabricated. Throughout the
process, red flags were over-looked, process requirements were waived, and exceptions
to policy were granted.”325
The presentation noted that the loan delinquency rate for Luis Fragoso, the loan officer
heading the Montebello loan office, was “289% worse than the delinquency performance for the
entire open/active retail channel book of business,” while the delinquency rate for Thomas
Ramirez, the loan officer heading the Downey loan office was 157% worse.326 The message
from the Risk Mitigation Team was clear that the two head loan officers were willfully flouting
bank policy, issuing poor quality loans, and needed to be the subject of “firm action” by the
Three months prior to its formal presentation on the fraud, the Risk Mitigation Team
supplied a lengthy email with its fraud findings to colleagues in the credit risk department. The
August 2005 email provided spreadsheets containing data collected on the loans from the two
offices as well as figures about the types of loans reviewed and fraud found.327 Among other
information, it indicated that at the Downey office, 83 loans had been reviewed, including 28
originated by the WaMu loan officer Thomas Ramirez, and 54 submitted to him by third party
brokers; while at the Montebello office, 48 loans had been reviewed, including 19 originated by
the WaMu loan officer Luis Fragoso and 29 submitted to him by third party brokers. The email
was forwarded by a credit risk officer to WaMu’s Chief Risk Officer Jim Vanasek, with the
following comment:
“As you requested in our Enterprise Fraud Committee meeting last Friday, the attached
email contains a high-level summary of the investigations the Home Loans Risk Mit team
has conducted on [the two offices] over the past year and a half, based on loans that were
referred to them. … As you can see, among the referred cases there is an extremely high
323 Id. at JPM_WM02481936.
324 Id. at JPM_WM02481938.
325 Id. at JPM_WM02481943.
326 Id. at JPM_WM02481948.
327 8/29/2005 email from Jill Simons to Tim Bates, JPM_WM04026076-77, Hearing Exhibit 4/13-23b.
incidence of confirmed fraud (58% for Ramirez, 83% for Fragoso) …. [Additional
analysis] will allow us to substantially validate what we suspect, which is that the
incidence of fraud in this area is greater than with other producers.”328
At the Subcommittee hearing, Mr. Vanasek agreed these were “eye popping” rates of fraud.329
On November 18, 2005, Cheryl Feltgen, the Home Loans Chief Credit Officer, “had a
very quick meeting” with Home Loans President David Schneider, the head of Home Loans
sales Tony Meola, and others in which she reviewed the memorandum and presentation on the
fraud investigation.330 After the meeting, she sent an email to the Risk Mitigation Team stating:
“The good news is that people are taking this very seriously. They requested some additional
information that will aid in making some decisions on the right course of action.”331 She asked
the Risk Mitigation Team to prepare a new spreadsheet with the loan information, which the
team did over the weekend in anticipation of a Monday meeting.
The trail of documentation in 2005 about the fraud investigation ends there. Despite the
year-long effort put into the investigation, the written materials prepared, the meetings held, and
fraud rates in excess of 58% and 83% at the Downey and Montebello offices, no discernable
actions were taken by WaMu management to address the fraud problem in those two offices. No
one was fired or disciplined for routinely violating bank policy, no anti-fraud program was
installed, no notice of the problem was sent to the bank’s regulators, and no investors who
purchased RMBS securities containing loans from those offices were alerted to the fraud
problem underlying their high delinquency rates. Mr. Vanasek retired from the bank in
December 2005, and the new Chief Risk Officer Ron Cathcart was never told about the fraud
investigation. Senior personnel, including Mr. Schneider, Mr. Meola, and Ms. Feltgen, failed to
follow up on the matter.
Over the next two years, the Downey and Montebello head loan officers, Mr. Ramizez
and Mr. Fragoso, continued to issue high volumes of loans332 and continued to win awards for
their loan productivity, including winning trips to Hawaii as members of WaMu’s “President’s
Club.” One of the loan officers even suggested to bank President Steve Rotella ways to further
relax bank lending standards.333
In June 2007, however, the fraud problem erupted again. That month, AIG, which
provided mortgage insurance for some of WaMu’s residential mortgages, contacted the bank
with concerns about material misrepresentations and fraudulent documents included in
328 8/30/2005 email from Tim Bates to Jim Vanasek and others, JPM_WM04026075, Hearing Exhibit 4/13-23b.
329 April 13, 2010 Subcommittee Hearing at 28.
330 11/18/2005 email from Cheryl Feltgen to Nancy Gonseth on the Risk Mitigation Team and Tim Bates,
JPM_WM03535695, Hearing Exhibit 4/13-23a.
331 Id.
332 At the Subcommittee’s hearing, Mr. Vanasek testified that as much as $1 billion in loans originated out of these
two offices per year. April 13, 2010 Subcommittee Hearing at 27.
333 See, e.g., 3/2006 WaMu email chain, JPM_WM03985880-83.
mortgages being issued by Mr. Fragoso, the loan officer heading the Montebello office.334 When
no one responded to its concerns, in September 2007, AIG filed a Suspected Fraud Claim with
the California Department of Insurance which, in turn, notified OTS of the problem.335 The OTS
Examiner-in-Charge at WaMu at the time, Benjamin Franklin, asked the bank to conduct an
investigation into the matter.336 WaMu’s legal department asked the WaMu Corporate Fraud
Investigation (CFI) group and the Audit department to conduct a joint inquiry.
Seven months later, in April 2008, CFI and the Audit department issued a 12-page
memorandum with their findings.337 The memorandum not only confirmed the presence of fraud
in the Montebello office, citing a loan file review that found a fraud rate of 62%, it also
uncovered the 2005 investigation that had identified the problem two years earlier, but was
ignored by management. The 2008 memorandum stated:
“In 2005, HL [Home Loans] Risk Mitigation provided Senior HL Management with an
assessment of fraud and loan performance in the Retail Broker Program and two
Southern California Emerging Markets [loan centers] for the period of September 2003
through August 2005. This assessment identified excessive levels of fraud related to loan
qualifying data …. It also highlighted the Downey and Montebello [loan centers] as the
primary contributors of these fraudulent loan documents based upon volume and
articulated strategies to mitigate fraud. The report also stated that delinquency
performance on these [loan centers] … were significantly worse that the delinquency
performance for the entire open/active retail channel book of business. In 2007, HL Risk
Mitigation mirrored their 2005 review with a smaller sample of loans and found that, for
the September and October 2007 sampled time period, the volume of misrepresentation
and suspected loan fraud continued to be high for this [loan center] (62% of the sampled
Examples of fraudulent loan information uncovered in the 2007 review included falsified income
documents, unreasonable income for the stated profession, false residency claims, inflated
appraisal values, failure of the loan to meet bank guidelines, suspect social security numbers,
misrepresented assets, and falsified credit information.339
The memorandum found that, in 2005, the WaMu Risk Mitigation Team had reported its
findings to several WaMu managers whom it “felt were very aware of high volumes of fraud” in
the loans issued by the two loan officers.340
334 4/4/2008 WaMu Memorandum of Results, “AIG/UG and OTS Allegation of Loan Frauds Originated by [name
redacted],” at 1, Hearing Exhibit 4/13-24.
The memorandum reported that one individual
believed that David Schneider “was made aware of these findings” and wanted Risk Mitigation
335 Id. at 1.
336 Subcommittee interview of Benjamin Franklin (2/18/2010).
337 4/4/2008 WaMu Memorandum of Results, “AIG/UG and OTS Allegation of Loan Frauds Originated by [name
redacted],” at 1, Hearing Exhibit 4/13-24.
338 Id. at 2.
339 Id. at 3.
340 Id. at 7.
to “monitor the situation.”341 But no one knew “of additional monitoring that was done, or
efforts to bring additional attention to” the fraudulent loans from the Downey and Montebello
offices. The memorandum also noted that no personnel action had been taken against either of
the loan officers heading the two offices.342 David Schneider was interviewed and “recalled
little about the 2005 fraud findings or actions taken to address them.”343 He “thought the matter
was handled or resolved.” The WaMu memorandum concluded:
“Outside of training sessions … in late 2005, there was little evidence that any of the
recommended strategies were followed or that recommendations were operationalized.
There were no targeted reviews conducted … on the Downey or Montebello loan
portfolios between 2005 and the actions taken in December 2007.”344
After the memorandum was issued, WaMu initially resisted providing a copy to OTS,
claiming it was protected by attorney-client privilege.345 The OTS Examiner-in-Charge
Benjamin Franklin told the Subcommittee that he insisted on seeing the memorandum. After
finally receiving it and reading about the substantial loan fraud occurring at the two loan offices
since 2005, he told the Subcommittee that it was “the last straw” that ended his confidence that
he could rely on WaMu to combat fraudulent practices within its own ranks.
The 2008 WaMu memorandum and a subsequent OTS examination memorandum346
included a number of recommendations to address the fraud problem at the Downey and
Montebello offices. The recommendations in the WaMu memorandum included actions to
“[d]etermine appropriate disciplinary actions for employees”; “[e]nhance Code of Conduct
training to stress each employee’s role as a corporate steward and the consequences for passively
facilitating the placement of loans into the origination process that could be suspect”; enhance
WaMu compensation incentives “to support loan quality”; and determine if further analysis was
required of the loans originated by the Montebello office or “the broader loan population (bank
owned and securitized)” including “if actions are needed to address put backs or sales to
investors of loans that contain misrepresentation[s] or other fraud findings.”347
By the time WaMu issued the April 2008 memorandum on the Downey and Montebello
fraud problem, however, the bank was already experiencing serious liquidity problems and was
cutting back on its loan operations and personnel. On April 30, 2008, WaMu put an end to its
wholesale loan channel which had accepted loans from third party mortgage brokers, closed 186
341 Id.
342 Id.
343 Id. at 8.
344 Id. at 9.
345 Subcommittee interview of Benjamin Franklin (2/18/2010).
346 1/7/2008 OTS Asset Quality Memo 22, “Loan Fraud Investigation,” JPM_WM02448184, Hearing Exhibit 4/13-
347 4/4/2008 WaMu Memorandum of Results, “AIG/UG and OTS Allegation of Loan Frauds Originated by [name
redacted],” at 4, Hearing Exhibit 4/13-24.
stand-alone loan centers, and reduced its workforce by 3,000.348 The Downey and Montebello
offices were closed as part of that larger effort. The two loan officers heading those offices left
the bank and found other jobs in the mortgage industry that involve making loans to borrowers.
Other Fraud Problems. The loan fraud problems at the Downey and Montebello offices
were not the only fraud problems plaguing WaMu. The Subcommittee uncovered three
additional examples that demonstrate the problem was not isolated.
The first example involves the Westlake Village loan office outside of Los Angeles. On
April 1, 2008, WaMu’s Risk Mitigation Team sent thirteen home loans with early payment
defaults to the WaMu Corporate Fraud Investigations (CFI) group for further examination.349
All thirteen, whose unpaid loan balances totaled about $14.3 million, had been issued in 2007, by
the Westlake Village loan office which was one of WaMu’s top loan producers. Two loan
officers, Chris O’Brien and Brian Minkow, who worked in tandem, had won multiple awards for
their loan production and had a team of 14 sales associates assisting them.350 CFI reviewed the
referred loans which contained a variety of fraud indicators, including “fabricated asset
statements, altered statements, income misrepresentation and one altered statement that is
believed to have been used in two separate loans.”351 CFI then interviewed the loan officers,
sales associates, and personnel at the WaMu “loan fulfillment center” (LFC) that processed
Westlake Village loan applications.
In one egregious example of document “manufacturing,” a sales associate confessed that
if “it was too late to call the borrower,” the “sales associates would take [bank] statements from
other [loan] files and cut and paste the current borrower’s name and address” onto the old bank
statements.352 The same sales associate “admitted that during that crunch time some of the
Associates would ‘manufacture’ asset statements from previous loan docs,” because end-ofmonth
loans would often get funded without full documentation. The pressure to get the
necessary documentation was “tremendous” and they had been told to get the loans funded “with
whatever it took.”353
The LFC loan processor in charge of handling Westlake Village’s loan applications was
fired, as was the sales associate who confessed to manufacturing false documents. The rest of
the employees were also let go, when the office itself was closed on April 30, 2008, in
348 Subcommittee interview of Brian Minkow (2/16/2010); 5/27/2008 “Internal Investigative Report” on Westlake
Home Loan Center, JPM_WM03171384, Hearing Exhibit 4/13-31. See also “Washington Mutual Exits Wholesale
Lending Business, Will Close Home-Loan Centers,” Mercury News, 4/7/2008,
349 5/12/2008 “WaMu Significant Incident Notification (SIN),” JPM_WM05452386, Hearing Exhibit 4/13-30.
350 Subcommittee interview of Brian Minkow (2/16/2010). See also 2005 “President’s Club 2005 - Maui, Awards
Night Show Script,” Washington Mutual, Home Loans Group, Hearing Exhibit 4/13-63a (stating Mr. O’Brien and
Mr. Minkow had produced $1.2 billion in loans in 2005).
351 Id.
352 5/27/2008 “Internal Investigative Report” on Westlake Home Loan Center, JPM_WM03171384, Hearing Exhibit
353 5/12/2008 “WaMu Significant Incident Notification (SIN),” JPM_WM05452386, Hearing Exhibit 4/13-30.
connection with WaMu’s reorganization and downsizing. One of the loan officers who headed
the office told the Subcommittee, however, that he had been offered another job within the bank,
but declined it due to lower compensation.354 He went on to work in the mortgage industry
arranging residential loans.
The second example involves 25 Home Equity Lines of Credit (HELOCs) totaling $8.5
million that were originated in 2008 by a WaMu loan officer at the Sunnyvale loan office in
California. Before all of the loans were funded, they were referred to the Risk Mitigation Team
because of fraud indicators. On May 1, 2008, the loan files were sent on to the CFI group for
further inquiry. An internal document summarizing the CFI investigation stated:
“The review found that the borrowers indicated they owned the property free and clear
when in fact existing liens were noted on the properties. The properties are located in
California, Arizona and Washington. … WaMu used … Abbreviated Title reports [that]
… do not provide existing lien information on the subject property.”355
Of the 25 loan applications, 22 were ultimately terminated or declined. The employee involved
in originating the loans was terminated as part of the April 30, 2008 reorganization.
The third example involves a review of 2006 and 2007 WaMu loans conducted by Radian
Guaranty Inc., a company which provided mortgage insurance for those loans.356 Radian’s
objectives were to test WaMu’s “compliance with Radian’s underwriting guidelines and eligible
loan criteria,” assess the quality of WaMu’s underwriting decisions, “rate the risk of the
individual loans insured,” and identify any errors in the loan data transmitted to Radian.357 The
review looked at a random selection of 133 loans and found enough problems to give WaMu an
overall rating of “unacceptable.”358
The Radian review identified a number of problems in the loan files it deemed ineligible
for insurance. In one, WaMu issued a $484,500 loan to a “Sign Designer” who claimed to be
making $34,000 in income every month.359
354 Subcommittee interview of Brian Minkow (2/16/2010).
The Radian review observed: “Borrower’s stated
monthly income of $34,000 does not appear reasonable for a ‘Sign Designer.’” The review also
noted several high risk elements in the loan, which was an 85% LTV loan given to a borrower
with a 689 credit score who used the loan to refinance an existing loan and “cash-out” the equity
in the house. The review noted that the borrower received $203,000 at the loan closing. In
addition, the review stated that WaMu had appraised the house at $575,000, but an automated
appraisal verification program assigned the house a probable value of only $321,000, less than
the amount of the loan.
355 5/15/2008 “WaMu Significant Incident Notification (SIN),” JPM_WM05452389, Hearing Exhibit 4/13-32b.
356 2/7/2008 Radian Guaranty Inc. review of Washington Mutual Bank loans, JPM_WM02057526, Hearing Exhibit
357 Id. at 1.
358 Id.
359 Id. at 5.
Extent of Fraud. At the Subcommittee hearing, when asked about these matters, Mr.
Vanasek, WaMu’s Chief Risk Officer from 2004 to 2005, attributed the loan fraud to
compensation incentives that rewarded loan personnel and mortgage brokers according to the
volume of loans they processed rather than the quality of the loans they produced:
“Because of the compensation systems rewarding volume versus quality and the
independent structure of the originators, I am confident at times borrowers were coached
to fill out applications with overstated incomes or net worth to meet the minimum
underwriting requirements. Catching this kind of fraud was difficult at best and required
the support of line management. Not surprisingly, loan originators constantly threatened
to quit and to go to Countrywide or elsewhere if the loan applications were not
When asked by Senator Coburn if he thought the type of fraud at the Downey and Montebello
loan offices extended beyond those two offices, Mr. Vanasek replied: “Yes, Senator.”361
Another sobering internal WaMu report, issued in September 2008, a few weeks before
the bank’s failure, found that loans marked as containing fraudulent information had nevertheless
been securitized and sold to investors. The report blamed ineffective controls that had “existed
for some time”:
“The controls that are intended to prevent the sale of loans that have been confirmed by
Risk Mitigation to contain misrepresentations or fraud are not currently effective. There
is not a systematic process to prevent a loan in the Risk Mitigation Inventory and/or
confirmed to contain suspicious activity from being sold to an investor. ... Of the 25
loans tested, 11 reflected a sale date after the completion of the investigation which
confirmed fraud. There is evidence that this control weakness has existed for some
Loans not meeting the bank’s credit standards, deliberate risk layering, sales associates
manufacturing documents, offices issuing loans in which 58%, 62%, or 83% contained evidence
of loan fraud, and selling fraudulent loans to investors are evidence of deep seated problems that
existed within WaMu’s lending practices. Equally disturbing is evidence that when WaMu
senior managers were confronted with evidence of substantial loan fraud, they failed to take
corrective action. WaMu’s failure to strengthen its lending practices, even when problems were
identified, is emblematic of how lenders and mortgage brokers produced billions of dollars in
high risk, poor quality home loans that contributed to the financial crisis.
360 April 13, 2010 Subcommittee Hearing at 17.
361 Id. at 30.
362 9/8/2008 “WaMu Risk Mitigation and Mortgage Fraud 2008 Targeted Review,” JPM_WM00312502, Hearing
Exhibit 4/13-34.
(d) Steering Borrowers to High Risk Option ARMs
In addition to subprime loans, Washington Mutual made a variety of high risk loans to
“prime” borrowers, including its flagship product, the Option Adjustable Rate Mortgage
(“Option ARM”). Washington Mutual’s Option ARMs typically offered borrowers an initial
teaser rate, sometimes as low as 1% for the first month, which later adjusted to a much higher
floating interest rate linked to an index, but gave borrowers the choice each month of paying a
higher or lower amount. These loans were called “Option” ARMs, because borrowers were
typically given four options: (1) paying the fully amortizing amount needed to pay off the loan
in 30 years; (2) paying an even higher amount to pay off the loan in 15 years; (3) paying only the
interest owed that month and no principal; or (4) making a “minimum payment” that covered
only a portion of the interest owed and none of the principal.363 If the borrower selected the
minimum payment option, unpaid interest would be added to the loan principal. If the borrower
repeatedly selected the minimum payment, the loan principal would increase rather than decrease
over time, creating a negatively amortizing loan.
Negative amortization created additional credit risk for WaMu and posed a challenge to
risk managers. At the April 13 Subcommittee hearing, Mr. Vanasek testified:
“We had concerns from the standpoint of negative amortization that was accumulating
and we had been reassured that in the past, borrowers would negatively amortize during
difficult times and then make up for the lost payments in good times. But the percentage
and the potential percentage for negative amortization was very large, and, of course the
attendant payment shock was also very large, which was a concern to credit.”364
Few executives at WaMu shared Mr. Vansek’s concern about the Option ARM. To the extent
that risk managers expressed concern, it was outweighed by the product’s favorable gain-onsale
As part of its High Risk Lending Strategy, WaMu determined to increase its issuance of
its Option ARM loans. To do that, WaMu had to convince customers to forego a simple, low
risk conventional loan in favor of the complex and higher risk Option ARM. In late 2003,
WaMu conducted two focus group studies to “explore ways to increase sales of Option ARMs,
Washington Mutual’s most profitable mortgage loan products.”365 The first focus group
examined the views of WaMu loan consultants and third party mortgage brokers. The second
focus group examined the views of WaMu Option ARM customers.
The report following the first focus group with WaMu loan consultants and mortgage
brokers identified a number of impediments to selling Option ARMs. It noted that Option ARM
363 See 8/2006 “Option ARM Credit Risk,” WaMu presentation, at 3, Hearing Exhibit 4/13-37; 10/17/2006 “Option
ARM” draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38.
364 April 13, 2010 Subcommittee Hearing at 49.
365 9/17/2003 “Option ARM Focus Groups – Phase II, WaMu Option ARM Customers,” WaMu research report, at
3, Hearing Exhibit 4/13-35.
loans had to be “sold” to customers asking for a 30-year fixed loan, and training was needed to
overcome the feeling of “many” WaMu loan consultants that Option ARMs were “bad” for their
customers. The report also recommended increasing commissions so salespersons would take
the “hour” needed to sell an Option ARM, and increasing loan processing times so salespersons
and brokers were not inconvenienced. The report stated in part:
“Option ARMs are sold to customers and few walk through the door and ask for them. ...
If salespeople don’t understand Option ARMs, they won’t sell them. Many felt that more
training would be needed to better educate salespeople about this type of loan, and to
change the mindset of current Loan Consultants. Some felt there were many within
Washington Mutual who simply felt these loans were ‘bad’ for customers, probably from
a lack of understanding the product and how it could benefit customers. ...
It is critical that salespeople fully understand a customer’s financial situation and
motivation for the loan. By taking into account these factors, they can recommend the
loan that will best fit their customers’ needs. Given today’s low interest rate
environment, it can be challenging to get salespeople to take the time to do this.
Currently it is easier to give customers what they ask for (a 30 year fixed loan) than to
sell them an Option ARM. They can take 20 minutes and sell a 30 fixed-rate loan, or
spend an hour trying to sell an Option ARM.
Commission caps make it unappealing for Mortgage Brokers to sell Washington Mutual
Option ARMs. Most would not sell loans to customers with prepayment penalties, and
given the low commission rate for selling them without the prepayment penalty, many
simply go to another company or product where they can make more money.
Slow ARM processing times (up to 90 days) can cause Mortgage Brokers to take
business elsewhere…
Improving collateral would help salespeople better explain Option ARMs to customers
and take away some of the mystery. … They also would like improved brochures which
talk to the customer in simple, easy to understand terms about features and benefits.
They liked the current sample statements they are provided.”366
The second focus group with existing Option ARM customers showed they were also
unenthusiastic about the product. The focus group report stated:
“In general, people do not seem to have a good understanding of their mortgage and its
terms. What understanding they do have is framed by the concept of a 30-year fixed
mortgage. Option ARMs are very complicated and need to be explained in simple, easy
366 8/14/2003 “Option ARM Focus Groups – Phase I, WaMu Loan Consultants and Mortgage Brokers,” WaMu
research report, at 3, Hearing Exhibit 4/13-36 [emphasis in original].
to understand terms, prospective borrowers need to be educated about the loan – this is
not a product that sells itself.”367
The focus group identified several reasons that borrowers were leery of Option ARMs
and suggested ways to address the unease: “Helping prospective borrowers understand payment
and interest rate caps may mitigate fears of wild monthly payment swings .… Similarly, fears
about negative amortization, a concept also not very well understood by the participants, could
be reduced or eliminated by showing how much residential properties in the local market have
appreciated over time.”368
The main findings of the focus group included:
“Few participants fully understood the Option ARM and its key benefits. A number of
them were not familiar with the payment options or how they could be used. …
Additionally, most did not understand how their interest rate was derived, how often their
payments would change, and what, if any, were the interest and/or payment caps.
“Perhaps the best selling point for the Option ARM loan was being shown how much
lower their monthly payment would be by choosing an Option ARM versus a fixed-rate
“Many participants did not know what happened to their loan at the end of the fixed
interest rate period. Most of them assumed they would have to sell or refinance because
of a potential balloon payment or a steep jump in their payments. Because of these
misperceptions, most participants expect to refinance their loans within the next three to
five years.”369
To increase Option ARM sales, WaMu increased the compensation paid to its loan
personnel and outside mortgage brokers for the loans.370 The bank also qualified borrowers for
Option ARMs by using a monthly payment amount that was less than what the borrower would
likely pay once the loan recast.371
The Option ARM was also frequently featured in sales promotion efforts communicated
to loan officers through WaMu’s internal alert email system known as, “e-Flash.” For example,
a June 5, 2006 e-Flash from Steve Stein, the Director of Retail Lending in the Home Loans
division, to the entire retail sales team announced:
367 9/17/2003 “Option ARM Focus Groups – Phase II, WaMu Option ARM Customers,” WaMu research report, at

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