Sunday, September 4, 2011


4, Hearing Exhibit 4/13-35.
368 Id.
369 Id. at 5 [emphasis in original].
370 Subcommittee interview of David Schneider (2/17/2010).
371 See April 13, 2010 Subcommittee Hearing at 50.
“We are beginning to focus on higher-margin products like our flagship product, the
Option ARM. This is a fantastic product for almost any borrower. To help our sales
force feel more comfortable with selling the Option ARM to a wide variety of borrowers,
we are rolling out a comprehensive skills assessment and training initiative. ... This
initiative is not about selling the Option ARM to everyone. We will always stay true to
our values and provide the right loan for every customer. … Through the skills
assessment, training, role playing and a best-practices selling tips video, I think this retail
sales team will be unstoppable with the Option ARM. … The Option ARM is our
product and we can sell it better than anyone. I have great confidence that we’ll improve
our Option ARM market share quickly, like the experts that we are.”372
One month later, Mr. Stein announced increased compensation incentives for selling
Option ARMs. In another e-Flash to the entire retail sales team, Mr. Stein wrote:
“You’ve seen and heard a lot recently about our refined business model and focus on
higher margin products, especially Option ARMs. To further drive this focus, I’m
pleased to announce the 2006 Option ARM Blitz – Quarterly Incentive Campaign. This
will allow eligible Loan Consultants to earn 5 additional basis points on all Option ARM
volume funded during the 3rd quarter 2006.”373
Under the rules of the Option ARM Blitz, loan consultants who increased the percentage of
Option ARMs they sold by at least 10% would receive an additional bonus. In August 2006, an
e-Flash announced that the underwriting guidelines for Option ARMs had been loosened,
allowing higher loan amounts for “condos and co-ops” and greater loan-to-value ratios for “lowdoc”
second home mortgages.374 Also in August, an e-Flash announced that the “Option ARM
Sales Mastery Program” that was launched in June, would now become part of the mandatory
loan originator training curricula.375
In September 2006, WaMu introduced pricing incentives for Option ARMs in the
consumer direct channel which waived all closing costs for Option ARMs except for an appraisal
deposit.376 In the fourth quarter of 2006, the consumer direct channel also held a contest called
the “Fall Kickoff Contest.” For each of the 13 weeks in the quarter, the loan consultant who
scored the most points would receive a $100 gift card. An Option ARM sale was a “touchdown”
and worth seven points; jumbo-fixed, equity, and nonprime mortgages were only “field goals”
worth three points. At the end of the quarter the top five point winners were awarded with a
$1,000 gift card.377
372 6/5/2006 “e-Flash” from Steve Stein to Retail Production Sales, JPM_WM03246053.
In addition, from November 2006 through January 2007, e-Flashes sent to
373 7/3/2006 “e-Flash” from Steve Stein to Retail Production Sales, JPM_WM04471136-37.
374 8/17/2006 “e-Flash” from Steve Stein, Arlene Hyde, and John Schleck to Production and Operations,
375 8/18/2006 “e-Flash” from Allen Myers to Retail Production Sales Managers, JPM_WM03277758.
376 8/31/2006 “e-Flash” from Mary Ann Kovach to Consumer Direct, JPM_WM03077747.
377 10/12/2006 “e-Flash” from Mary Ann Kovach to Consumer Direct, JPM_WM03627448-49.
consumer direct originators promoted Option ARM sales specials offering $1,000 off closing
costs for loans under $300,000 and a waiver of all fees for loans greater than $300,000.378
Judging by sales of Option ARMs in 2004, after the completion of the focus groups,
WaMu’s strategy to push sales of Option ARM loans was successful. In 2003, WaMu originated
$30.1 billion in Option ARMs; in 2004 WaMu more than doubled its Option ARM originations
to $67.5 billion. Although sales of Option ARMs declined thereafter because of challenges in
the market, in 2006, WaMu still originated $42.6 billion in Option ARMs. According to its
internal documents, by 2006, Washington Mutual was the second largest Option ARM originator
in the country.379
As WaMu’s Option ARM portfolio grew, and as the wider economy worsened, the
prevalence of negative amortization in the Option ARMs increased. While WaMu risk managers
viewed negative amortization as a liability, WaMu accountants, following generally accepted
accounting practices, treated negative amortization as an asset. In 2003, WaMu recognized $7
million in earnings from deferred interest due to negative amortization.380 By 2006, capitalized
interest recognized in earnings that resulted from negative amortization surpassed $1 billion; by
2007 it exceeded $1.4 billion.381 In other words, as WaMu customers stopped paying down their
mortgages, WaMu booked billions of dollars in earnings from the increasing unpaid balances.
By another measure, in 2003, $959 million in Option ARM loans that WaMu held in its
investment portfolio experienced negative amortization; in 2007, the figure was more than $48
According to data compiled by the Treasury and the FDIC Inspectors General, in 2005,
WaMu borrowers selected the minimum monthly payment option for 56% of the value of the
Option ARM loans in its investment portfolio. By the end of 2007, 84% of the total value of the
Option ARMs in WaMu’s investment portfolio was negatively amortizing.383 To avoid having
their loans recast at a higher interest rate, Option ARM borrowers typically refinanced the
outstanding loan balance. Some borrowers chose to refinance every year or two.384 The
Treasury and the FDIC IG report determined that a significant portion of Washington Mutual’s
Option ARM business consisted of refinancing existing loans.385
One WaMu loan officer, Brian Minkow, told the Subcommittee that he expected the vast
majority of Option ARMs borrowers to sell or refinance their homes before their payments
378 See, e.g., 11/13/2006 “e-Flash” from Mary Ann Kovack to Consumer Direct, JPM_WM03077089-90.
As long as home prices were appreciating, most borrowers were able to refinance if
379 2007 “Home Loans Product Strategy,” WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a
(only Countrywide ranked higher).
380 2005 Washington Mutual Inc. 10-K filing with the SEC at 27.
381 Id.
382 Id. at 55; 3/2007 Washington Mutual Inc. 10-K filing with the SEC at 57.
383 4/2010 IG Report, at 9, Hearing Exhibit 4/16-82.
384 Subcommittee interview of Brian Minkow (2/16/2010).
385 4/2010 IG Report, Hearing Exhibit 4/16-82.
386 Subcommittee interview of Brian Minkow (2/16/2010).
they chose to. According to Mr. Minkow, who was one of WaMu’s top loan consultants and in
some years originated more than $1 billion in loans, 80% of his business was in Option ARMs,
and 70% of his business consisted of refinances.387 Once housing prices stopped rising,
however, refinancing became difficult. At recast, many people found themselves in homes they
could not afford, and began defaulting in record numbers.
WaMu was one of the largest originators of Option ARMs in the country. In 2006 alone,
WaMu securitized or sold $115 billion in Option ARMs.388 Like Long Beach securitizations,
WaMu Option ARM securitizations performed badly starting in 2006, with loan delinquency
rates between 30 and 50%, and rising.389
(e) Marginalization of WaMu Risk Managers
WaMu knowingly implemented a High Risk Lending Strategy, but failed to establish a
corresponding system for risk management. Instead, it marginalized risk managers who warned
about and attempted to limit the risk associated with the high risk strategy.
At the time it formally adopted its High Risk Lending Strategy, WaMu executives
acknowledged the importance of managing the risks it created. For example, the January 2005
“Higher Risk Lending Strategy ‘Asset Allocation Initiative’” presentation to the Board of
Directors Finance Committee stated in its overview:
“In order to generate more sustainable, consistent, higher margins within Washington
Mutual, the 2005 Strategic Plan calls for a shift in our mix of business, increasing our
Credit Risk tolerance while continuing to mitigate our Market and Operational Risk
“The Corporate Credit Risk Management Department has been tasked, in conjunction
with the Business Units, to develop a framework for the execution of this strategy. Our
numerous activities include:
-Selecting best available credit loss models
-Developing analytical framework foundation
-Identifying key strategy components per Regulatory Guidance documents
“A strong governance process will be important as peak loss rates associated with this
higher risk lending strategy will occur with a several year lag and the correlation between
high risk loan products is important. For these reasons, the Credit Department will pro-
387 Id.
388 10/17/2006 “Option ARM” draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing
Exhibit 4/13-38, chart at 2.
389 See (subscription website maintained by JPMorgan Chase with data on Long Beach and
WaMu mortgage backed securities showing, as of January 2011, delinquency rates for particular mortgage backed
securities, including WMALT 2006 OA-3 – 57.87% and WAMU 2007-OA4 – 48.43%).
actively review and manage the implementation of the Strategic Plan and provide
quarterly feedback and recommendations to the Executive Committee and timely
reporting to the Board.”390
The robust risk management system contemplated by in the January 2005 memorandum,
which was critical to the success of the High Risk Lending Strategy, was never meaningfully
implemented. To the contrary, risk managers were marginalized, undermined, and often ignored.
As former Chief Risk Manager Jim Vanasek testified at the April 13 Subcommittee hearing:
“I made repeated efforts to cap the percentage of high-risk and subprime loans in the
portfolio. Similarly, I put a moratorium on non-owner-occupied loans when the
percentage of these assets grew excessively due to speculation in the housing market. I
attempted to limit the number of stated income loans, loans made without verification of
income. But without solid executive management support, it was questionable how
effective any of these efforts proved to be.”391
Later in the hearing, Mr. Vanasek had the following exchange with Senator Coburn:
Senator Coburn: Did you ever step in and try to get people to take a more conservative
approach at WaMu?
Mr. Vanasek: Constantly.
Senator Coburn: Were you listened to?
Mr. Vanasek: Very seldom.
Senator Coburn: [Had] you ever felt that your opinions were unwelcomed, and could you
be specific?
Mr. Vanasek: Yes. I used to use a phrase. It was a bit of humor or attempted humor. I
used to say the world was a very dark and ugly place in reference to subprime loans. I
cautioned about subprime loans consistently.392
Mr. Vanasek’s description of his efforts is supported by contemporaneous internal
documents. In a February 24, 2005 memorandum to the Executive Committee with the subject
heading, “Critical Pending Decisions,” for example, Mr. Vanasek cautioned against expanding
WaMu’s “risk appetite”:
390 1/2005 “Higher Risk Lending Strategy ‘Asset Allocation Initiative,’” Washington Mutual Board of Directors
Finance Committee Discussion, JPM_WM00302975, Hearing Exhibit 4/13-2a [emphasis in original].
391 April 13, 2010 Subcommittee Hearing at 17.
392 Id. at 32.
“My credit team and I fear that we are considering expanding our risk appetite at exactly
the wrong point and potentially walking straight into a regulatory challenge and criticism
from both the Street and the Board. Said another way I fear that the timing of further
expansion into higher risk lending beyond what was contemplated in the ’05 Plan and
most especially certain new products being considered is ill-timed given the overheated
market and the risk [of] higher interest rates….
So we come down to the basic question, is this the time to expand beyond the ’05 Plan
and/or to expand into new categories of higher risk assets? For my part I think not. We
still need to complete EDE [Enterprise Decision Engine, an automated underwriting
system], reduce policy exception levels, improve the pricing models, build our sub-prime
collection capability, improve our modeling etc. We need to listen to our instincts about
the overheated housing market and the likely outcome in our primary markets. We need
to build further credibility with the regulators about the control exercised over our SFR
underwriting and sub-prime underwriting particularly in LBMC.”393
Mr. Vanasek retired in December 2005, in part, because the management support for his
risk policies and culture was lacking.394 When Mr. Vanasek left WaMu, the company lost one of
the few senior officers urging caution regarding the high risk lending that came to dominate the
bank. After his departure, many of his risk management policies were ignored or discarded. For
example, by the end of 2007, stated income loans represented 73% of WaMu’s Option ARMs,
50% of its subprime loans, and 90% of its home equity loans.395
Ronald Cathcart was hired in December 2005 to replace Mr. Vanasek, and became the
Chief Enterprise Risk Officer. He had most recently been the Chief Risk Officer for Canadian
Imperial Bank of Commerce’s retail bank.396 Although the High Risk Lending Strategy was
well underway, after Mr. Vanasek’s departure, risk management was in turmoil. Mr. Cathcart
testified at the Subcommittee hearing: “When I arrived at WaMu, I inherited a Risk Department
that was isolated from the rest of the bank and was struggling to be effective at a time when the
mortgage industry was experiencing unprecedented demand for residential mortgage assets.” In
early 2006, the bank reorganized WaMu’s risk management.397 Under the new system, much of
the risk management was subordinated to the WaMu business divisions, with each business
division’s Chief Risk Officer reporting to two bosses, Mr. Cathcart and the head of the business
unit to which the Risk Officer was assigned. WaMu referred to this system of reporting as a
393 2/24/2005 Washington Mutual memorandum from Jim Vanasek to the Executive Committee, “Critical Pending
Decisions,” JPM_WM01265462-64.
394 Subcommittee interview of Jim Vanasek (12/18/2009 and 1/19/2010).
395 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82.
396 Subcommittee interview of Ronald Cathcart (2/23/2010).
397 Id.
398 Id.; Subcommittee interviews of David Schneider (2/17/2010) and Cheryl Feltgen (2/6/2010).
Cheryl Feltgen, for example, was the Chief Risk Officer for the Home Loans division.
She reported both to Mr. Cathcart and to Mr. Schneider, the Home Loans President, setting up a
tension between the two.399 Mr. Schneider had hired Ms. Feltgen from Citi Mortgage, where she
had been the Chief Marketing Officer, not a risk manager. Mr. Cathcart told the Subcommittee
that he would not have hired her for the role, because of her lack of risk management
Ms. Feltgen told the Subcommittee that, although she was the Home Loans Chief Risk
Officer, she also had responsibility to meet business goals. She indicated that she did not see her
role as one of risk minimization, but rather of risk optimization.401 Her 2007 performance
evaluation reflected her dual responsibilities, but clearly subordinated her risk management
duties to the achievement of business growth objectives. For example, the evaluation identified a
series of goals and assigned each a percentage weighting to determine their precedence. Instead
of assigning priority to her performance in the area of managing risk, Ms. Feltgen’s number one
performance goal for 2007 was “GROWTH” in home loans, given a weighting of 35%, followed
by “RISK MANAGEMENT,” given a weighting of only 25%.402 Her performance review even
listed specific sales targets:
“Employee Goals
1. Achieve Net Income - $340 MM for 2007
2. HL [Home Loan] Product Sales (Incl. Conduit)
1. Home Equity - $18B
2. Subprime - $32B
3. Option ARM - $33B
4. Alt A - $10B
3. Customer Satisfaction (Total HL) – 55%”403
By conditioning her evaluation on whether her division hit pre-determined sales figures, the
performance evaluation made her compensation more dependent upon the Home Loans division
hitting revenue growth and product sales than upon her contributions to risk management.
Further complicating matters were Ms. Feltgen’s two supervisors. In an interview, Ms.
Feltgen stated that Ron Cathcart, her supervisor on risk matters, was “not well respected” and
did not have “a strong voice.” 404
399 See April 13, 2010 Subcommittee Hearing at 34; Subcommittee interviews of Mr. Cathcart (2/23/2010), Mr.
Schneider (2/17/2010), and Ms. Feltgen (2/6/2010).
On the other hand, she described David Schneider, her
400 Subcommittee interview of Ronald Cathcart (2/23/2010).
401 Subcommittee interview of Cheryl Feltgen (2/6/2010).
402 “Performance Review Form: Leadership,” Hearing Exhibit 4/13-64 (the form is not dated, but Ms. Feltgen
confirmed that it is the 2007 review).
403 Id.
404 Subcommittee interview of Cheryl Feltgen (2/6/2010).
supervisor on loan origination matters, as having a strong voice and acting more as her boss.
This arrangement again de-emphasized the importance of her risk duties.
Ms. Feltgen’s dedication to the growth of the Home Loans business is apparent in her
communications with her staff. For example, on December 26, 2006, she sent a year-end email
to her staff. Under the subject line, “Year-End 2006 Message for the Home Loans Risk
Management Team,” Ms. Feltgen wrote:
“As we approach the close of 2006, it is fitting to reflect on the challenges and
accomplishments of this past year and to look forward to 2007 and beyond. Earlier this
year David Schneider and the leadership team of Home Loans articulated a new business
strategy that included: (1) a shift to higher margin products (Alt-A, subprime and home
equity); (2) reducing market risk… and taking on more credit risk and (3) aggressively
attacking the cost structure. We have made great strides as a business on all of those
fronts and you have all been a part of those accomplishments. You have partnered
successfully with the business units of Home Loans in pursuit of our collective goal to
drive profitable growth with the right balance of risk and return.”405
The email continued with a list of “accomplishments of the Home Loans Risk
Management Team in support of business goals,” that included the following accomplishment:
“Our appetite for credit risk was invigorated with the expansion of credit guidelines for various
product segments including the 620 to 680 FICO, low docs and also for home equity.”406 The
email continued with Ms. Feltgen stating her commitment to the High Risk Lending Strategy and
emphasizing revenue and sales despite an acknowledgement of the worsening condition of the
mortgage market:
“The year 2007 will be another challenging year for the mortgage industry with mortgage
origination volumes down, the inverted yield curve putting pressure on profitability and
gain on sale margins at lower level than prior years. The focus on the three key elements
of our 2006 strategy remains important: shift to higher margin products, reduce market
risk and increase credit risk and attack the cost structure. … In 2007, we must find new
ways to grow our revenue. Home Loans Risk Management has an important role to play
in that effort.
“David Schneider has encouraged us to ‘BE BOLD’…. Recognize that ‘we are all in
sales’ passionately focused on delivering great products and service to our customers.”407
Ms. Feltgen’s year-end bonus was based upon her performance review.408
405 1/3/2007 email from Cheryl Feltgen, “Year-End 2006 Message for the Home Loans Risk Management Team,”
Hearing Exhibit 4/13-73.
According to
Mr. Cathcart, in 2007, the bank made bonus distributions more dependent on the performance of
406 Id.
407 Id.
408 Subcommittee Interview of Ronald Cathcart (2/23/2010).
each business line, rather than the performance of the bank as a whole, which largely removed
his control over compensation of his risk managers. Mr. Cathcart told the Subcommittee that he
disagreed with this change because it made his risk managers, who reported to him and to the
heads of the business units, more beholden to the business heads. Mr. Cathcart said he
approached the head of Human Resources, and strongly objected to the change, but was told to
take it up with Mr. Killinger. Mr. Cathcart told the Subcommittee that he voiced his objection to
Mr. Killinger, but Mr. Killinger told him to talk to Mr. Rotella. He said that he took his
objection to Mr. Rotella, but was unsuccessful at preventing the policy change.
Mr. Cathcart told the Subcommittee that this change created further separation between
him and his risk managers, and compromised the independence of risk management.409 He
testified at the Subcommittee hearing:
Mr. Cathcart: The chairman adopted a policy of what he called double reporting, and in
the case of the Chief Risk Officers, although it was my preference to have them reporting
directly to me, I shared that reporting relationship with the heads of the businesses so that
clearly any of the Chief Risk Officers reporting to me had a direct line to management
apart from me.
Senator Coburn: And was that a negative or a positive in terms to the ultimate outcome
in your view?
Mr. Cathcart: It depended very much on the business unit and on the individual who was
put in that double situation. I would say that in the case of home loans, it was not
satisfactory because the Chief Risk Officer of that business favored the reporting
relationship to the business rather than to risk.410
The subordination of risk management to sales was apparent at WaMu in many other
ways as well. Tony Meola, the head of home loans sales, reported directly to David Schneider.
He had direct access to Mr. Schneider and often pushed for more lenient lending standards.
According to Ms. Feltgen, the sales people always wanted more lenient standards and more
mortgage products, and Mr. Meola advocated for them.411
One example was the 80/20 loan, which consisted of a package of two loans issued
together, an 80% LTV first lien and a 20% LTV second lien, for a total CLTV of 100%. Ms.
Feltgen said she was nervous about the product, as a 100% CLTV was obviously very risky.
WaMu’s automatic underwriting system was not set up to accept such loans, but Mr. Meola
wanted permission to “side step” the systems issue.412
409 Id.
Mr. Schneider approved the product, and
Ms. Feltgen ultimately signed off on it. She told the Subcommittee that it was a high risk
410 April 13, 2010 Subcommittee Hearing at 34.
411 Subcommittee Interview of Cheryl Feltgen (2/6/2010).
412 See 2/2006 WaMu internal email chain, “FW: 80/20,” JPM_WM03960778.
product, but was priced accordingly, and that it might have been successful if housing prices had
not declined.413
When the housing market began to collapse, a time in which prudent risk management
became even more critical, Mr. Cathcart, the Chief Enterprise Risk Manager, was accorded even
less deference and authority. Mr. Cathcart testified at the April 13th hearing:
“Financial conditions… deteriorated further in 2007 and 2008. As head of risk, I began
to be excluded from key management decisions. By February 2008, I had been so fully
isolated that I initiated a meeting with the Director, where I advised that I was being
marginalized by senior management to the point that I was no longer able to discharge
my responsibilities as Chief Enterprise Risk Officer of WaMu. Within several weeks, I
was terminated by the Chairman.”414
During his interview with the Subcommittee Mr. Cathcart provided additional detail
about his marginalization by senior management.415 He said that he initially had extensive
interaction with the WaMu Board of Directors and presented to the full Board every six months.
According to Mr. Cathcart, he attended all of the Board meetings until the end of 2007 or the
beginning of 2008, at which time he was no longer invited. Mr. Cathcart felt he was excluded
from Board meetings and calls with investment bankers because he was forthright about
WaMu’s mortgage loss rates, whereas senior management used older, more favorable numbers.
According to Mr. Cathcart, during one of the last Board meetings he attended, after a
presentation on expected mortgage losses, he interjected that the loan loss data being presented
were already out of date, and the real figures would be much worse. He also recalled speaking
up in a 2007 conference call with investment bankers to correct an overly optimistic loss figure.
According to Mr. Cathcart, he was chastised for his corrections by WaMu management and told
to leave the credit discussions to another senior manager.
Mr. Cathcart told the Subcommittee that regulators were also given out-of-date loss
projections as the situation worsened, because Mr. Killinger and Mr. Rotella wanted to prevent a
negative reaction. Mr. Cathcart said that the loss rates were increasing every week, and the
regulators were being provided with three-week old information. Mr. Cathcart told the
Subcommittee that in February or March 2008, he discovered that Mr. Killinger had provided the
Director of OTS, John Reich, with out-of-date loss rates. Mr. Cathcart said that he called a
meeting with Mr. Dochow, head of the OTS West Regional Office, and provided him with the
current numbers. Mr. Cathcart said that Mr. Killinger found out about the meeting and was
upset. In April, Mr Killinger fired Mr. Cathcart.
413 Subcommittee Interview of Cheryl Feltgen (2/6/2010). See also 2/2006 WaMu internal email chain, “FW:
80/20,” JPM_WM03960778.
414 April 13, 2010 Subcommittee Hearing at 19.
415 Subcommittee interview of Ronald Cathcart (2/23/2010).
E. Polluting the Financial System
Washington Mutual, as the nation’s largest thrift, was a leading issuer of home loans.
When many of those loans began to go bad, they caused significant damage to the financial
Washington Mutual originated or acquired billions of dollars of home loans through
multiple channels, including loans originated by its own loan officers, loans brought to the bank
by third party mortgage brokers, and loans purchased in bulk from other lenders or firms. Its
subprime lender, Long Beach, originated billions of dollars in home loans brought to it by third
party mortgage brokers across the country. According to a 2007 WaMu presentation, by 2006,
Washington Mutual was the second largest nonagency issuer of mortgage backed securities in
the United States, behind Countrywide.416
Washington Mutual and Long Beach sold or securitized the vast majority of their
subprime home loans. Initially, Washington Mutual kept most of its Option ARMs in its
proprietary investment portfolio, but eventually began selling or securitizing those loans as well.
With respect to other loans, such as fixed rate 30-year, Alt A, home equity, and jumbo loans,
WaMu kept a portion for its own investment portfolio, and sold the rest either to Wall Street
investors, usually after securitizing them, or to Fannie Mae or Freddie Mac.
By securitizing billions of dollars in poor quality loans, WaMu and Long Beach were
able to decrease their risk exposure while passing along risk to others in the financial system.
They polluted the financial system with mortgage backed securities which later incurred high
rates of delinquency and loss. At times, WaMu securitized loans that it had identified as likely
to go delinquent, without disclosing its analysis to investors to whom it sold the securities, and
also securitized loans tainted by fraudulent information, without notifying purchasers of the
fraud that was discovered and known to the bank.
(1) WaMu and Long Beach Securitizations
From 2000 to 2007, Washington Mutual and Long Beach securitized at least $77 billion
in subprime and home equity loans.417 WaMu also sold or securitized at least $115 billion in
Option ARM loans.418 Between 2000 and 2008, Washington Mutual sold over $500 billion in
loans to Fannie Mae and Freddie Mac, accounting for more than a quarter of every dollar in
loans WaMu originated.419
416 See 6/11/2007 chart entitled, “Rate of Growth Exceeds the Industry,” JPM_WM03409860, Hearing Exhibit 4/13-
417 6/2008 “WaMu Wholesale Specialty Lending Securitization Performance Summary,” JPM_WM02678980,
Hearing Exhibit 4/13-45.
418 10/17/2006 “Option ARM” draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing
Exhibit 4/13-38 (see chart at 2). See also 8/2006 “Option ARM Credit Risk,” WaMu presentation, at
JPM_WM00212644, Hearing Exhibit 4/13-37 (see chart at 5).
419 See chart in section E(4), below, using loan data from Inside Mortgage Finance.
According to a 2007 WaMu presentation at a securities investor meeting in New York, in
2004, WaMu issued $37.2 billion in RMBS securitizations and was the sixth largest RMBS
issuer in the United States.420 In 2005, it doubled its production, issuing $73.8 billion in
securitizations, and became the third largest issuer. In 2006, it issued $72.8 billion and was the
second largest issuer, behind Countrywide.421
WaMu and Long Beach’s securitizations produced only RMBS securities. Although
WaMu considered issuing CDO securities as well, it never did so.422 From 2004 to 2006, WaMu
and Long Beach securitized dozens of pools of prime, subprime, Alt A, second lien, home
equity, and Option ARM loans.423 WaMu and Long Beach also sold “scratch and dent” pools of
nonperforming loans, including nonperforming primary mortgages, second lien, and Option
At first, Washington Mutual worked with Wall Street firms to securitize its home loans,
but later built up its own securitization arm, Washington Mutual Capital Corporation (WCC),
which gradually took over the securitization of both WaMu and Long Beach loans. WCC was a
private Washington State corporation that WaMu acquired from another bank in 2001, and
renamed.425 WCC became a wholly owned subsidiary of Washington Mutual Bank. In July
2002, WaMu announced that WCC would act as an institutional broker-dealer handling RMBS
securities and would work with Wall Street investment banks to market and sell WaMu and
Long Beach RMBS securities.426
WCC was initially based in Seattle, and by 2003, had between 30 and 40 employees.427
In 2004, due to increasing securitizations, WaMu decided to move the headquarters of WCC to
Manhattan.428 In 2004, for the first time, WCC acted as the lead manager of a WaMu
securitization. That same year, WCC initiated a “conduit program” to buy Alt A and subprime
loans in bulk for securitization.429 WCC issued its first Alt A securitization in 2005, and its first
subprime securitization in 2006.430
420 See 6/11/2007 chart entitled, “Rate of Growth Exceeds the Industry,” JPM_WM03409860, Hearing Exhibit 4/13-
It also conducted whole loan sales and credit card
421 Id. WaMu attributed its rapid rise in the issuer rankings over the three-year period to its establishment of a
Conduit Program, which began buying loans in bulk in 2004. Id.
422 See 12/15/2006 Enterprise Risk Management Committee, JPM_WM02656967. See also 10/25/2006 Asset-
Liability Management Committee Meeting Agenda, JPM_WM02406624.
423 See 6/2008 “WaMu Wholesale Specialty Lending Securitization Performance Summary,” JPM_WM02678980,
Hearing Exhibits 4/13-45 and 46; 6/11/2007 chart entitled, “WaMu Capital Corp Sole/Lead Underwriter,”
JPM_WM03409861, Hearing Exhibit 4/13-47c.
424 See, e.g., undated “List of WaMu-Goldman Loans Sales and Securitizations,” Hearing Exhibit 4/13-47b; 2/2007
internal WaMu email chain, JPM_WM00652762.
425 See 6/11/2007 chart entitled, “Capital Markets Division Growth,” JPM_WM03409858, Hearing Exhibit 4/13-
426 Id.
427 Subcommittee interview of David Beck (3/2/2010).
428 Id.
429 See 6/11/2007 chart entitled, “Capital Markets Division Growth,” JPM_WM03409858, Hearing Exhibit 4/13-
430 Id.
securitizations.431 At its peak, right before the collapse of the subprime securitization market,
WCC had over 200 employees and offices in Seattle, New York, Los Angeles, and Chicago. The
majority of WCC employees were based in New York.432 WCC was headed by Tim Maimone,
WCC President, who reported to David Beck, Executive Vice President in charge of WaMu’s
Capital Markets Division. Mr. Beck reported to the President of WaMu’s Home Loans Division,
David Schneider.433
At the Subcommittee hearing on April 13, 2010, Mr. Beck explained the role of WCC in
WaMu and Long Beach securitizations as follows:
“WaMu Capital Corp. acted as an underwriter of securitization transactions generally
involving Washington Mutual Mortgage Securities Corp. or WaMu Asset Acceptance
Corp. Generally, one of the two entities would sell loans into a securitization trust in
exchange for securities backed by the loans in question, and WaMu Capital Corp. would
then underwrite the securities consistent with industry standards. As an underwriter,
WaMu Capital Corp. sold mortgage-backed securities to a wide variety of institutional
WCC sold WaMu and Long Beach loans and RMBS securities to insurance companies, pension
funds, hedge funds, other banks, and investment banks.435 It also sold WaMu loans to Fannie
Mae and Freddie Mac. WCC personnel marketed WaMu and Long Beach loans both in the
United States and abroad.
Before WCC was able to act as a sole underwriter, WaMu and Long Beach worked with
a variety of investment banks to arrange, underwrite, and sell its RMBS securitizations, including
Bank of America, Credit Suisse, Deutsche Bank, Goldman Sachs, Lehman Brothers, Merrill
Lynch, Royal Bank of Scotland, and UBS. To securitize its loans, WaMu typically assembled
and sold a pool of loans to a qualifying special-purpose entity (QSPE) that it established for that
purpose, typically a trust.436
431 Id.
The QSPE then issued RMBS securities secured by future cash
flows from the loan pool. Next, the QSPE—working with WCC and usually an investment
bank—sold the RMBS securities to investors, and used the sale proceeds to repay WaMu for the
432 Subcommittee interview of David Beck (3/2/2010).
433 Id.
434 April 13, 2010 Subcommittee Hearing at 53. Washington Mutual Mortgage Securities Corp. (WMMSC) and
WaMu Asset Acceptance Corp. (WAAC) served as warehouse entities that held WaMu loans intended for later
securitization. Mr. Beck explained in his prepared statement: “WMMSC and WAAC purchased loans from WaMu,
and from other mortgage originators, and held the loans until they were sold into the secondary market. WCC was a
registered broker-dealer and acted as an underwriter of securitization deals for a period of time beginning in 2004
and ending in the middle of 2007. In addition to buying and selling mortgage loans, WMMSC acted as a ‘master
servicer’ of securitizations. The master servicer collects and aggregates the payments made on loans in a securitized
pool and forwards those payments to the Trustee who, in turn, distributes those payments to the holders of the
securities backed by that loan pool.” Id. at 163.
435 See 6/11/2007 chart entitled, “Origination Through Distribution,” JPM_WM03409859, Hearing Exhibit 4/13-
47c; Subcommittee interview of David Beck (3/2/2010).
436 See 3/2007 Washington Mutual Inc. 10-K filing with the SEC, at 45 (describing securitization process).
cost of the loan pool. Washington Mutual Inc. generally retained the right to service the loans.
WaMu or Long Beach might also retain a senior, subordinated, residual, or other interest in the
loan pool.
The following two diagrams created for a 2005 Long Beach securitization, LBMC 2005-
2, demonstrate the complex structures created to issue the RMBS securities, as well as the
“waterfall” constructed to determine how the mortgage payments being made into the
securitization pool would be used.437
437 See “LBMC 2005-2 Structure” and “LBMC 2005-2 Cash Flow Waterfall,” FDIC_WAMU_000012358-59,
Hearing Exhibit 47a.
In that particular securitization, Goldman Sachs served as the lead underwriter, WCC served as
the securities dealer, Deutsche Bank served as the trustee of the trust set up to hold the securities,
and Long Beach served as the mortgage servicer.
Another document, prepared by Goldman Sachs, shows the variety of relationships that
WaMu engaged in as part of its securitization efforts.438 That document, which consists of a list
of various loan pools and related matters, shows that WaMu worked with Goldman Sachs to
make whole loan sales; securitize loans insured by the Federal Home Administration or Veterans
Administration; and securitize prime, subprime, Alt A, second lien, and scratch and dent
nonperforming loans. It also shows that Goldman Sachs asked WaMu and Long Beach to
repurchase more than $19.7 million in loans it had purchased from the bank.439
Goldman Sachs handled a number of securitizations for Long Beach. At one point in
2006, Goldman Sachs made a pitch to also handle loans issued by WaMu. One Goldman Sachs
broker explained to a colleague in an email: “They have possibly the largest subprime portfolio
on the planet.”440
(2) Deficient Securitization Practices
Over the years, both Long Beach and Washington Mutual were repeatedly criticized by
the bank’s internal auditors and reviewers, as well as its regulators, OTS and the FDIC, for
deficient lending and securitization practices. Their mortgage backed securities were among the
worst performing in the marketplace due to poor quality loans that incurred early payment
defaults, fraud, and high delinquency rates.
Long Beach Securitizations. In April 2005, an internal email sent by an OTS regulator
recounted eight years of abysmal performance by Long Beach securities, noting that loan
delinquencies and losses occurred in pools containing both fixed rate and adjustable rate
“[Securitizations] prior to 2003 have horrible performance…. For FRM [fixed rate
mortgage] losses, LBMC finished in the top 12 worst annual NCLs [net credit losses] in
1997 and 1999 thru 2003. LBMC nailed down the number 1 spot as top loser with an
NCL of 14.1% in 2000 and placed 3rd in 2001 with 10.5% .... For ARM losses, LBMC
really outdid themselves with finishes as one of the top 4 worst performers for 1999 thru
2003. For specific ARM deals, LBMC made the top 10 worst deal list from 2000 thru
2002. LBMC had an extraordinary year in 2001 when their securitizations had 4 of the
top 6 worst NCLs (range: 11.2% to 13.2%).
438 Undated “List of WaMu-Goldman Loans Sales and Securitizations,” Hearing Exhibit 4/13-47b.
439 Id.
440 3/24/2005 email from Kevin Gasvoda of Goldman Sachs to Christopher Gething, others, Hearing Exhibit 4/27-
“Although underwriting changes were made from 2002 thru 2004, the older issues are
still dragging down overall performance. Despite having only 8% of UPB [unpaid
balances] in 1st lien FRM pools prior to 2002 and only 14.3% in 2002 jr. lien pools,
LBMC still had third worst delinquencies and NCLs for most of [the] period graphed
from 11/02 thru 2/05 and was 2nd worst in NCLs in 2005 out of 10 issuers graphed. … At
2/05, LBMC was #1 with a 12% delinquency rate. Industry was around 8.25%. At 3/05,
LBMC had a historical NCL rate of 2% smoking their closest competitor by 70bp and
tripling the industry average.”441
This email, which is based upon a 2005 Fitch analysis of Long Beach, shows that,
from 1997 to March 2005, due to loan delinquencies and losses, Long Beach securities
were among the very worst performing in the entire subprime industry.442
Long Beach’s performance did not improve after 2005. In April 2006, for
example, Nomura Securities issued an analysis of the ABX Index that tracked a basket of
20 subprime RMBS securities and identified Long Beach as the worst performer:
“Long Beach Mortgage Loan Trust appears to be the poorest performing issuer, with its
three deals averaging 15.67% in 60+ day delinquency and 12.75% in 90+ day
delinquency. Unsurprisingly, all three deals issued by LBMLT have exceeded their
delinquency trigger limits.”443
In November 2006, while attending the Asset Backed Securities East Conference
for the securitization industry, the head of WaMu’s Capital Markets Division, David
Beck, emailed WaMu’s Home Loans President, David Schneider, that with respect to
RMBS securities carrying noninvestment grade ratings, “LBMC [Long Beach] paper is
among the worst performing paper in the mkt [market] in 2006. Subordinate buyers want
In March 2007, an analysis by JPMorgan Chase again singled out Long Beach securities
for having the worst delinquency rates among the subprime securities tracked by the ABX Index:
“Washington Mutual Inc.’s subprime bonds are suffering from some of the worst rates of
delinquency among securities in benchmark indexes, according to JPMorgan Chase &
Co. research. … Delinquencies of 60 days or more on loans supporting WaMu’s Long
Beach LBMLT 2006-1 issue jumped … to 19.44 percent … the highest among the 20
441 4/14/2005 email from Steve Blelik to David Henry, “Fitch – LBMC Review,” Hearing Exhibit 4/13-8a.
442 Id.
443 4/19/2006 “ABX Index – The Constituent Breakdown,” prepared by Nomura Securities International Inc.,
444 11/7/2006 email from David Beck to David Schneider, Hearing Exhibit 4/13-50. See also 4/19/2006 “ABX
Index – The Constituent Breakdown,” prepared by Nomura Securities International Inc.,
bonds in the widely watched ABX-HE 06-2 index of bonds backed by residential loans to
risky borrowers.”445
In July 2007, Moody’s and S&P downgraded the credit ratings of hundreds of subprime
RMBS and CDO securities, due to rising mortgage delinquencies and defaults. Included were
approximately 40 Long Beach securities.446 A July 12, 2007 presentation prepared by Moody’s
to explain its ratings action shows that Long Beach was responsible for only 6% of all the
subprime RMBS securities issued in 2006, but received 14% of the subprime RMBS ratings
downgrades that day.447 Only Fremont had a worse ratio.
Over time, even AAA rated Long Beach securities performed terribly. Of the 75 Long
Beach mortgage backed security tranches rated AAA by Standard and Poor’s in 2006, all 75
have been downgraded to junk status, defaulted, or been withdrawn.448 In most of the 2006
Long Beach securitizations, the underlying loans have delinquency rates of 50% or more.449
The problems were not confined to Long Beach loans. In early 2008, for example, an
investment adviser posted information on his personal blog about a WaMu-sponsored RMBS
securitization known as WMALT 2007-OC1. Formed in May 2007, this pool contained about
1,700 Alt A loans with a total outstanding balance of about $515 million. WaMu was the sole
underwriter. The credit rating agencies gave AAA and other investment grade ratings to more
than 92% of the securitization, but within eight months, 15% of the pool was in foreclosure. The
posting suggested that the poor performance of WaMu securities was systemic.
When informed by David Schneider of the complaint about the negative publicity
surrounding the pool, David Beck responded:
“Yes (ughh!) we are doing some peer group performance and looking at the servicing
data … and putting together an analysis. … The collateral is full of limited doc layered
risk alt a paper and at least half is TPO [third party originated]. The performance is not
great but my opinion is not a WaMu specific issue.”450
445 “WaMu subprime ABS delinquencies top ABX components,” Reuters (3/27/2007), Hearing Exhibit 4/13-52.
446 7/10/2007-7/12/2007 excerpts from Standard & Poor’s and Moody’s Downgrades, Hearing Exhibit 4/23-99.
447 7/12/2007 “Moody’s Structured Finance Teleconference and Web Cast: RMBS and CDO Rating Actions,”
MOODYS-PSI2010-0046902, Hearing Exhibit 4/23-106.
448 See Standard and Poor’s data at
449 See, e.g., (subscription website maintained by JPMorgan Chase with data on Long Beach
and WaMu mortgage backed securities showing, as of March 2011, delinquency rates for particular mortgage
backed securities, including LBMLT 2006-1 – 58.44%; LBMLT 2006-6 – 60.06%; and LBMLT 2005-11 –
450 2/2/2008 email from David Beck to David Schneider and others, JPM_WM02445758, Hearing Exhibit 4/13-51.
Home Loans President David Schneider replied: “Ok – thanks .… Are we sure there isn’t a
reporting issue?” Today, those securities have all been downgraded to junk status and more than
half of the underlying loans are delinquent or in foreclosure.451
Despite their poor performance, it is unclear that any investment bank refused to do
business with either Long Beach or WaMu. As long as investors expressed interest in
purchasing the securities, banks continued selling them until the entire subprime market
collapsed. Before the market collapsed, WaMu earned hundreds of millions of dollars a year
from its home loans sales and securitizations.452
Securitizing Fraudulent Loans. WaMu and Long Beach securitized not just poor
quality loans, but also loans that its own personnel had flagged as containing fraudulent
information. That fraudulent information included, for example, misrepresentations of the
borrower’s income and of the appraised value of the mortgaged property. In September 2008,
WaMu’s Corporate Credit Review team released a report which found that internal controls
intended to prevent the sale of fraudulent loans to investors were ineffective:
“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
In other words, even loans marked with a red flag indicating fraud were being sold to investors.
The review identified several factors contributing to the problem, including insufficient resources
devoted to anti-fraud work, an absence of automated procedures to alert personnel to fraud
indicators, and inadequate training on fraud awareness and prevention. The 2008 review
warned: “Exposure is considerable and immediate corrective action is essential in order to limit
or avoid considerable losses, reputation damage, or financial statement errors.”454
(3) Securitizing Delinquency-Prone Loans
The Subcommittee uncovered an instance in 2007 in which WaMu securitized certain
types of loans that it had identified as most likely to go delinquent, but did not disclose its
analysis to investors who bought the securities. Investors who purchased these securities without
the benefit of that analysis quickly saw the value of their purchases fall.
451 As of December 2010, the total loan delinquency rate of the WMALT 2007-OC1 series was 57.37%. See
452 See 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC, at 82, 87.
453 9/8/2008 “Risk Mitigation and Mortgage Fraud 2008 Targeted Review,” WaMu Corporate Credit Review,
JPM_WM00312502, Hearing Exhibit 4/13-34.
454 Id.
WaMu securitization agreements prohibited the bank from using an “adverse selection”
process when including loans within a securitized pool. On March 22, 2007, WaMu filed a
prospectus for WMALT Series 2007-OA3, in which Washington Mutual Bank and Washington
Mutual Mortgage Securities Corp. co-sponsored a securitization of a $2.3 billion pool of Option
ARM loans. In the section entitled, “Representations and Warranties Regarding the Mortgage
Loans,” the prospectus stated:
“Washington Mutual Mortgage Securities Corp. and Washington Mutual Bank, as
applicable, used no adverse selection procedures in selecting the mortgage loans from
among the outstanding adjustable rate conventional mortgage loans owned by it which
were available for sale and as to which the representations and warranties in the mortgage
loan sale agreement could be made.”455
On the following page of the prospectus, under the section heading, “Criteria for
Selection of Mortgage Loans,” it stated:
“Each co-sponsor selected the mortgage loans it sold to the depositor from among its
portfolio of mortgage loans held for sale based on a variety of considerations, including
type of mortgage loan, geographic concentration, range of mortgage interest rates,
principle balance, credit scores and other characteristics described in Appendix B to this
prospectus supplement, and taking into account investor preferences and the depositor’s
objective of obtaining the most favorable combination of ratings on the certificates.”456
WaMu emails and memoranda obtained by the Subcommittee indicate that, prior to
assembling the loan pool used in the WMALT 2007-OA3 securitization, WaMu identified
delinquency-prone Option ARM mortgages in its “Held for Investment” loan portfolio and
transferred those loans to its portfolio of mortgages available for sale or securitization. WaMu
then used its “Held for Sale” loan portfolio to select the loans for the loan pool used in the
WMALT 2007-OA3 securitization. The prospectus provides a list of criteria used to select the
loans in the WMALT 2007-OA3 loan pool, but omits any mention of the fact that some of the
loans were selected using statistical analysis designed to identify Option ARM loans likely to go
delinquent quickly. The internal emails demonstrate that WaMu selected delinquency-prone
loans for sale in order to move risk from the bank’s books to the investors in WaMu securities,
and profit from its internal analysis, which was not available to the market.
On Thursday, September 14, 2006, John Drastal, then Senior Managing Director of
WCC, sent David Beck, head of WaMu’s Capital Markets Division, with copies to others, an
email regarding “Tom Casey visit,” with the importance marked “high.” Tom Casey was then
the Chief Financial Officer of Washington Mutual Bank. In the email Mr. Drastal relayed Mr.
Casey’s concern about WaMu’s exposure to Option ARM loans:
455 3/22/2007 WaMu Prospectus Supplement, “Washington Mutual Mortgage Pass-Through Certificates, WMALT
Series 2007-OA3,” at S-102, Hearing Exhibit 4/13-86b.
456 Id. at S-103.
“Tom just stopped by after the Lehman investor conference. He says equity investors are
totally freaking about housing now. He asked how we could prepare for this. A few
“2. On the portfolio side, he asked about exposure on option ARMs. We talked about
looking to potentially sell ’06 production Option ARMs in portfolio. He even said
looking at this quarter. I don’t think that this is possible but we should look at what the
credit composition of this product is and see if we can sell quickly if it’s the right thing to
do (see Nagle’s message). He doesn’t for[e]see a tainting issue if we are doing it for
credit issues. Youyi, can you get me a collateral strat from the portfolio?”457
Three months later, on Wednesday, February 14, 2007, a WaMu portfolio analyst and
trader, Michael Liu, sent an email to a senior official in WaMu’s portfolio management
department, Richard W. Ellson, with the subject line: “Option ARM MTA and Option ARM
MTA Delinquency.” The email included the abbreviations “MTA,” which stands for “Monthly
Treasury Average,” and “PPD,” which stands for “Payment Past Due.” The email provided a
description of Option ARM loans in WaMu’s investment portfolio that were delinquent in the
fourth quarter of 2006:
“Hi Rick,
“Attached is the spreadsheet with the total Option ARM MTA … and Option ARM MTA
>=1 PPD summary. Some points for the Option ARM MTA >=1PPD:
• $105mm in Nonaccrual is between FICO 501-540.
• $222mm in Nonaccrual between LTV 61-80.
• CA [California] represents the greatest amount of Delinquency (1PPD, 2PPD,
3PPD, nonaccrual)[.]
• Loans originated in 2004 and 2005 represent the highest amount of 3 PPD and
nonaccrual [.]”458
On the same day, Mr. Ellson forwarded the email to the Division Executive for Portfolio
Management and Research, Youyi Chen, with the following comments:
“Youyi – attached is a description of the Option ARMs that were delinquent in the
2006q4 [fourth quarter]. You can see that it is very much a function of FICOs and Low
Doc loans. We are in the process of updating the optimum pricing matrix. Mike did the
work. Your comments are appreciated.”459
457 9/14/2006 email from John Drastal to David Beck, with Youyi Chen and Doug Potolsky copied, “Tom Casey
visit,” Hearing Exhibit 4/13-40a.
458 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b.
459 Id.
Mr. Chen, in turn, forwarded the email to the head of WaMu’s Capital Markets Division,
David Beck. Mr. Chen’s introductory comments indicated that the research had been performed
in response to a question from WaMu Home Loans President David Schneider and was intended
to identify criteria for the loans driving delinquencies in the Option ARM portfolio:
“This answers partially [David] Schneider’s questions on break down of the option arm
“The details (1PPD tab) shows Low fico, low doc, and newer vintages are where most of
the delinquency comes from, not a surprise.”460
On the same day, February 14, Mr. Beck forwarded the entire email chain to David
Schneider and WaMu Home Loans Risk Officer Cheryl Feltgen, adding his own view:
“Please review. The performance of newly minted option arm loans is causing us
problems. Cheryl can validate but my view is our alt a (high margin) option arms [are]
not performing well.
“We should address selling 1Q [first quarter] as soon as we can before we loose [sic] the
oppty. We should have a figure out how to get this feedback to underwriting and
Mr. Beck’s message indicated that recently issued Option ARM loans were not
performing well, and suggested selling them before the bank lost the opportunity. WaMu would
lose the opportunity to sell those loans if, for example, they went delinquent, or if the market
realized what WaMu analysts had already determined about their likelihood of going delinquent.
Mr. Beck’s email proposed selling the loans during the first quarter of the year, already six
weeks underway, and “as soon as we can.”
Four days later, on Sunday, February 18, Mr. Schneider replied to the email chain by
requesting Ms. Feltgen’s thoughts. Later that day, Ms. Feltgen responded with additional
analysis and an offer to help further analyze the Option ARM delinquencies:
“The results described below are similar to what my team has been observing.
California, Option ARMs, large loan size ($1 to $2.5 million) have been the fastest
increasing delinquency rates in the SFR [Single Family Residence] portfolio. Although
the low FICO loans have … higher absolute delinquency rates, the higher FICOs have
been increasing at a faster pace than the low FICOs. Our California concentration is
getting close to 50% and many submarkets within California actually have declining
house prices according to the most recent OFHEO [Office of Federal Housing Enterprise
Oversight] data from third quarter of 2006. There is a meltdown in the subprime market
which is creating a ‘flight to quality’. I was talking to Robert Williams just after his
460 Id.
461 Id.
return from the Asia trip where he and Alan Magleby talked to potential investors for
upcoming covered bond deals backed by our mortgages. There is still strong interest
around the world in USA residential mortgages. Gain on sale margins for Option ARMs
are attractive. This seems to me to be a great time to sell as many Option ARMs as we
possibly can. Kerry Killinger was certainly encouraging us to think seriously about it at
the MBR [Monthly Business Review] last week. What can I do to help? David, would
your team like any help on determining the impact of selling certain groupings of Option
ARMs on overall delinquencies? Let me know where we can help. Thanks.”462
As Chief Risk Officer in WaMu’s Home Loans division, Ms. Feltgen pointed out some
counterintuitive features of the latest delinquencies, noting that the fastest increases in
delinquencies occurred in large loans and loans with high FICO scores. She also noted that the
subprime meltdown had led to a “flight to quality,” and that foreign investors still had a strong
interest in U.S. residential mortgages, suggesting that WaMu might be able to sell its likely-to-go
delinquent Option ARMs to those foreign investors. From her perspective as a risk manager, she
urged selling “as many Option ARMs as we can.”
Her email also indicated that the topic of selling more Option ARMs had come up during
the prior week at the monthly business review meeting, in which WaMu CEO Killinger
expressed interest in exploring the idea.463 Finally, Ms. Feltgen offered help in analyzing the
impact of selling “certain groupings of Options ARMs” on overall delinquencies. Removing
those problematic loans from the larger pool of Option ARM loans in the bank’s investment
portfolio would reduce loan delinquencies otherwise affecting the value of the portfolio as a
Mr. Schneider sent a second email at 11:00 at night that same Sunday providing
instructions for moving forward:
“Let[’]s do the following:
1. db [David Beck] - please select the potential sample portfolios - along the lines we
discussed at the mbr [Monthly Business Review]
2. cf [Cheryl Feltgen] - please run credit scenarios
3. db - coordinate with finance on buy/sell analysis
4. db/cf – recommendation”464
On Tuesday morning, February 20, 2007, Mr. Beck replied with additional analysis:
“Here’s how I see this going.
462 Id.
463 At the end of 2006, WaMu held about $63.5 billion in Option ARM mortgages, then comprising about 28% of its
investment portfolio. See 3/2007 Washington Mutual Inc. 10-K filing with the SEC, at 52.
464 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b.
“From the MBR [Monthly Business Review], my notes indicate two portfolios we
discussed for sale; the 2007 high margin production (Jan and Feb so far) and the seasoned
COFI book.465
“I will supply to Cheryl the loan level detail on both pools and the pricing assumptions
for losses. Cheryl, you need to run scenario analysis and on losses versus pricing AND
reserving assumptions. I can supply pricing assumptions but would like you to pull the
ALLL [Allowance for Loan and Lease Losses] against these pools.”466
Later that day, Ms. Feltgen forwarded the email chain to her team, changing the subject
DAYS: Option ARM MTA and Option ARM MTA Delinquency.” Clearly, time was of the
“See the attached string of emails. We are contemplating selling a larger portion of our
Option ARMs than we have in the recent past. Gain on sale is attractive and this could be
a way to address California concentration, rising delinquencies, falling house prices in
California with a favorable arbitrage given that the market seems not to be yet
discounting a lot for those factors. David Schneider has set a meeting for Friday morning
with David Beck and me to hear our conclusions and recommendations. See the
comments below about the information that we need to provide for this analysis. We will
get the pools by tomorrow at the latest. We will need to coordinate with Joe Mattey and
get input from him in order to make a judgment regarding the ALLL impact. ...
“In addition to the specific information that David Beck asks for, I would like your input
on portions of the Option ARM portfolio that we should be considering selling. We may
have a different view than David Beck’s team as to the most desirable to sell and we
should provide that input. Our suggestion, for instance, might include loans in California
markets where housing prices are declining. There may be other factors.
“I will need to get from you by Thursday, February 22 end of day a summary of our
conclusions and recommendations.”467
465 Option ARMs were considered a “high margin” product within WaMu, because they produced a relatively high
gain on sale when sold. See 4/18/2006 Washington Mutual Home Loans Discussion Board of Directors Meeting, at
JPM_WM00690894, Hearing Exhibit 4/13-3 (chart showing gain on sale margin by product). “COFI” stands for
“Cost of Funds Index” which is an index used to set variable interest rates. “Seasoned” means the loans are older
466 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b.
467 Id.
A WaMu risk analyst, Robert Shaw, replied the same day and identified eight specific
factors that were driving delinquencies in the Option ARM portfolio:
“I reviewed the HFI [Hold for Investment] prime loan characteristics that contributed to
rising 60+ delinquency rates468
“Below, I have listed the factors (layered), their percentage change in 60+ delinquency
rate over the last 12 months, and HFI balances as of January 2007.
between 1/06 - 1/07 [January 6 and 7]. The results of this
analysis show that seven combined factors contain $8.3 billion HFI Option ARM
balances which experienced above-average increases in the 60+ delinquency rate during
the last 12 months (a 821% increase, or 10 times faster than the average increase of 79%).
I recommend that we select loans with some or all of these characteristics to develop a
HFS [Hold for Sale] pool.
“1) HFI Option ARMs – 79% increase (.56% to 1.0%), $60.6 billion
2) Above + Vintages 2004-2007 – 179% increase (.33% to .92%), $47.8 billion
3) Above + CA – 312% increase (.16 to .66%), $23.7 billion
4) Above + NY/NJ/CT – 254% increase (.21 to .76%), $29.3 billion
5) Above + $351k-1mil – 460% increase (.12 to .70%), $17.2 billion
6) Above + FICO 700-739 – 1197% increase (.03% to .40%), $4.2 billion
7) Above + FICO 780+ - 1484% increase (.02% to .38%), $5.2 billion
8) Above + FICO 620-659 – 821% increase (.07 to .67%), $8.3 billion[.]”470
Essentially, the eight factors identified Option ARMs that were in certain states, like California,
had certain FICO scores or certain loan amounts, or were issued during the period 2004-2007.
Later that same day, Ms. Feltgen forwarded Mr. Shaw’s email to Mr. Beck, Mr. Chen,
and Mr. Ellson. Her email carried the subject line: “Some thoughts on target population for
potential Option ARM MTA loan sale.” She wrote:
“David, Youyi and Rick:
“My team and I look forward to receiving the loan level detail on the pools of Option
ARMs we are considering for sale. I thought it might be helpful insight to see the
information Bob Shaw provides below about the components of the portfolio that have
been the largest contributors to delinquency in recent times. I know this is mostly an
exercise about gain on sale, but we might also be able to accomplish the other purpose of
reducing risk and delinquency at the same time. Talk to you soon.”471
468 A “60+ delinquency rate” applies to loans in which a payment is late by 60 days or more.
469 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b.
470 2/20/2007 email from Robert Shaw to Cheryl Feltgen, Hearing Exhibit 4/13-41.
471 2/20/2007 email from Cheryl Feltgen to David Beck, Youyi Chen, and Richard Ellson, Hearing Exhibit 4/13-41.
A week later, on Sunday, February 25, 2007, Mr. Beck sent an email with the subject
heading, “HFI Option Arms redirect to HFS,” to much of WaMu’s top management, including
Mr. Schneider, Mr. Rotella, Mr. Casey, as well as the FDIC Examiner-In-Charge Steve Funaro,
and others. The email indicated that a decision had been made to sell $3 billion in recent Option
ARM loans, with as many as possible to be sold before the end of the quarter, which was four
weeks away:
“David [Schneider] and I spoke today. He’s instructed me to take actions to sell all
marketable Option Arms that we intend to transfer to portfolio in 1Q[first quarter], 2007.
That amounts to roughly 3B [$3 billion] option arms availab[l]e for sale. I would like to
get these loans into HFS [the Hold for Sale portfolio] immediately so that [I] can sell as
many as possible in Q1.
“John [Drastal], we are only targeting to sell Option Arms destined for portfolio since
year end at this point. I’ll need direction from you on any special accounting concerns or
documentation you will need to get these loans in the warehouse without tainting the HFI
[Hold for Investment] book.472
“Michelle, I believe this action requires MRC [Market Risk Committee] approval. Please
“This week I’ll work to get the necessary governance sign offs in place. Cheryl, please
direct me on what form the approval request should take and what committees should
review and authorize the request. I can pull all of the data.
“We continue to work with Cheryl and the credit risk team to analyze emerging credit
risks in our prime portfolio and recommend actions to mitigate them.
“Thanks for your help,
Two days later, on Tuesday, February 27, 2007, Mr. Chen sent an email with the subject
line, “HFI selection criteria changes,” to Michelle McCarthy, who was head of WaMu’s Market
Risk Management department474 as well as chair of both its Market Risk Committee and Asset
Liability Committee.475 The email was copied to Mr. Beck, Ms. Feltgen and others, and showed
that the implementation of the plan was underway:
472 Loans in a bank’s Hold for Investment portfolio receive different accounting treatment than loans in the bank’s
Hold for Sale portfolio, and generally accepted accounting principles (GAAP) frown upon frequent transfers
between the two portfolios. The GAAP principles were a key reason for Mr. Beck’s instruction that the transfer of
the Option ARM loans from WaMu’s HFI to HFS portfolios proceed “without tainting the HFI book.”
473 2/25/2007 email from David Beck to himself, David Schneider, Steve Rotella, Ron Cathcart, Tom Casey, Cheryl
Feltgen, others, Hearing Exhibit 4/13-42b.
474 12/28/2007 WaMu internal report, “Disclosure Management,” JPM_WM02414318.
475 3/9/2007 WaMu Market Risk Committee Meeting Minutes, Hearing Exhibit 4/13-43.
“After careful review with David and the teams, David suggested me to make the
following recommendations to MRC [Market Risk Committee] on the existing prime
HFI/HFS selection criteria
“1. Effective March 7th 2007, modify the portfolio option ARM and COFI ARM
retention criteria (see attached ‘existing HFI descriptions’, ‘section 1.01 to 1.11 and
section 2.01 to 2.08’) to include only following loans for the portfolio (HFI)
a. Super jumbo of size greater or equal to $ 3 MM (Risk based pricing applied,
but difficult to sale)
b. Advantage 90 (high LTV loans without MI, very little production as 80/10/10
gets popularity)
c. Foreign Nationals (Risk based pricing applied, but difficult to sale due to FICO
d. FICO less than 620, except employee loans in which case FICO can be restated
after closing.
e. 3-4 units (excessive S & P level hit calls for portfolio execution)
“2. Further more, we would like to request, transferring from HFI to HFS, all the
MTA option ARMs and COFI ARMs, funded or locked between January 1st, 2007 to
Mach [sic] 7th, 2007, and DO NOT fit the criteria listed above, and DO NOT fit the
criteria section 3.02 to 4.07 in the attached ‘existing HFI descriptions’)
“As a result of this change, we expected to securitize and settle about $ 2 billion more
option/COFI ARMs in Q1-07 (mostly margin greater than 295), and going forward $ 1
billion per month potential incremental volume into HFS. For your information, the
impact to gain on sale for the year is estimated to be about $180 MM pretax based on
current market, and the impacts to 2007 portfolio NII is estimated to be about - $ 80 MM
“Also included in the attachment, is a pool of $1.3 billion option/COFI ARMs funded to
portfolio between January 1st and February 22nd that will be re-classified as HFS based
on the above recommendations. We understand that this population of loans will be
growing from now to March 7th until the portfolio selection criteria are officially
“We expected to start marketing the deal on March 12th, your prompt response will be
greatly appreciated as the TSG [Technology Solutions Group] and QRM [Quantitative
Risk Management] teams also need time to implement the coding changes.”476
476 2/27/2007 email from Youyi Chen to Michelle McCarthy, with copies to David Beck, Cheryl Feltgen, Steve
Fortunato, and others, “HFI selection criteria changes,” Hearing Exhibit 4/13-42a [emphasis in original].
This email proposed several significant changes to WaMu’s treatment of its Option
ARMs. First, WaMu decided to require most of its Option ARMs to go directly into its Hold for
Sale portfolio instead of going into its Held for Investment portfolio. In light of its analysis that
Option ARM loans were rapidly deteriorating, the bank no longer wanted to treat them as
investments it would keep, but immediately sell them. Second, the only Option ARMs that it
would automatically direct into its investment portfolio were those that the bank considered to be
so obviously of poor quality that they were “non-salable,” according to another internal email.477
Third, WaMu proposed transferring all Option ARM loans originated in 2007 from the
investment portfolio to the sale portfolio. Since these three changes in how WaMu would treat
its Option ARMs had compliance, accounting, and tax consequences, they had to be approved by
the Market Risk Committee. That Committee was composed of senior risk officers throughout
the bank as well as senior managers in the bank’s finance, treasury, and portfolio management
departments. The email indicated that the changes needed to be implemented within about a
week so that marketing of some of the Option ARMs could begin by March 12.
On March 9, 2007 the Market Risk Committee met and approved the Option ARM
proposal. The minutes of that meeting describe the changes that had been proposed:
“- Change the Held for Investment (HFI) ARM and COFI ARM retention criteria to
include only the following loans for HFI effective March 12, 2007; Super jumbo ≥ $3.0
million, Advantage 90, Foreign Nationals, FICO < 620 except employee loans in which
case FICO can be re-stated after closing, and 3 to 4 units.
- Increase Prime Option ARM’s (including Second Liens) from $26.0 billion to $37.0
- Transfer up to $3.0 billion of saleable Option ARM and COFI ARM loans originated
between January 1, 2007 and March 12, 2007 from HFI to HFS (excluding HFI loans
described above).”478
The minutes also recorded an exchange between Ms. McCarthy and another Committee
member, Mr. Woods, who was the Chief Financial Officer of WaMu’s Home Loans division:
“A second part of the proposal requests approval to transfer up to $3.0 billion of saleable
Option ARM and COFI ARM loans originated since January 1, 2007 from HFI to Held
for Sale (HFS). In response to a question from Mr. Woods, Ms. McCarthy explained that
there are other Option ARM loans not included in the criteria that we are retaining in
portfolio. Ms. McCarthy noted that Ms. Feltgen ha[d] reviewed and approved this
proposal. Mr. Woods noted that Deloitte has reviewed the proposal as well.”479
477 2/27/2007 email from Youyi Chen to David Griffith, “Option ARM,” JPM_WM03117796 (“David, we sell all
295+ margin and other OA and COFI, and KEEP the 4 categories going forward due mostly to non-salable
478 3/9/2007 WaMu Market Risk Committee Meeting Minutes, Hearing Exhibit 4/13-43.
479 Id.
This exchange acknowledges that not all of the saleable Option ARM loans were diverted from
the HFI to the HFS portfolio. WaMu chose to keep some Option ARMs and make other Option
ARMs available for sale. The internal WaMu documents and communications reviewed by the
Subcommittee strongly suggest that the decision to transfer the most recently originated Option
ARMs from the Held-for-Investment portfolio to the Held-for-Sale portfolio was part of an effort
to sell loans thought to be prone to delinquency, before they became delinquent. None of the
hearing witnesses recalled how these loans were specifically selected for securitization, nor did
any deny that they may have been selected for their propensity toward delinquency.480
The Subcommittee investigation determined that WaMu carried out the plan as approved,
and transferred at least $1.5 billion Option ARMs originated in the first quarter of 2007, from the
HFI to HFS portfolio. Of these loans, about 1,900 with a total value of a little over $1 billion
were assembled into a pool and used in the WMALT 2007-OA3 securitization in March 2007.481
WMALT 2007-OA3 securities were issued with WaMu as the sole underwriter and sold to
None of the materials associated with the sale of the WMALT 2007-OA3 securities
informed investors of the process used to select the delinquency-prone Option ARMs from
WaMu’s investment portfolio and include them in the securitization.483 Nor did WaMu inform
investors of the internal analysis it performed to identify the delinquency-prone loans. Senator
Levin questioned Mr. Beck about this point at the April 13 Subcommittee hearing:
Senator Levin. When you said that investors were told of the characteristics of
loans, they were told of all the characteristics of loans. Did they know, were they
informed that loans with those or some of those characteristics had a greater
propensity towards delinquency in WaMu’s analysis? Were they told that?
Mr. Beck. They were not told of the WaMu analysis.484
Predictably, the securitization performed badly. Approximately 87% of the securities
received AAA ratings.485 Within 9 months, by January 2008, those ratings began to be
480 Mr. Schneider and Mr. Beck were asked about this matter at the hearing. See April 13, 2010 Subcommittee
Hearing at 75-82.
As of February 2010, more than half of the loans in WMALT Series 2007-OA3
481 4/10/2010 Subcommittee email from Brent McIntosh, Sullivan & Cromwell LLP, Counsel for JPMorgan Chase
[Sealed Exhibit].
482 3/22/2007 WaMu Prospectus Supplement, “Washington Mutual Mortgage Pass-Through Certificates, WMALT
Series 2007-OA3,” at S-102, Hearing Exhibit 4/13-86b.
483 See, e.g., id. See also April 13, 2010 Subcommittee Hearing at 80.
484 April 13, 2010 Subcommittee Hearing at 82.
485 4/11/2007 “New Issue: Washington Mutual Mortgage Pass-Through Certificates WMALT Series 2007-OA3
Trust,” S&P’s Global Credit Portal,
486 See 1/14/2008 “Moody’s takes negative rating actions on certain WaMu Option Arm deals issued in 2007,”
were delinquent, and more than a quarter were in foreclosure.487 All of the investment grade
ratings have been downgraded to junk status, and the investors have incurred substantial losses.
(4) WaMu Loan Sales to Fannie Mae and Freddie Mac
Washington Mutual had longstanding relationships with a number of government
sponsored enterprises (GSEs), including the Federal National Mortgage Association (Fannie
Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).488 Between 2000 and
2008, Washington Mutual sold over $500 billion in loans to Fannie Mae and Freddie Mac,
accounting for more than a quarter of every dollar in loans WaMu originated.489 While the
majority of those loans involved lower risk, fixed rate mortgages, WaMu also sold Fannie and
Freddie billions of dollars in higher risk Option ARMs.
Relationships with Fannie and Freddie. Fannie Mae and Freddie Mac purchase
residential mortgages that meet specified underwriting standards and fall below a specified dollar
threshold, so-called “conforming loans.” They often enter into multi-year contracts with large
mortgage issuers to purchase an agreed-upon volume of conforming loans at agreed-upon rates.
Prior to 2005, Washington Mutual sold most of its conforming loans to Fannie Mae, with
relatively little business going to Freddie Mac.490 From at least 1999 through 2004, WaMu sold
those loans to Fannie Mae through a long term “Alliance Agreement,”491 that resulted in its
providing more than 85% of its conforming loans to Fannie Mae.492 In 2004, WaMu calculated
that it “contributed 15% of Fannie Mae’s 2003 mortgage business,”493 and was “Fannie Mae’s
2nd largest provider of business (behind Countrywide).”494
487 “Select Delinquency and Loss Data for Washington Mutual Securitizations,” chart prepared by the
Subcommittee, Hearing Exhibit 4/13-1g.
Among the advantages that WaMu
believed it gained from its relationship with Fannie Mae were help with balance sheet
488 See 9/29/2005 “GSE Forum,” internal presentation prepared by WaMu, Hearing Exhibit 4/16-91 at
JPM_WM02575608. As mentioned earlier, GSEs are Congressionally chartered, nongovernment owned financial
institutions created for public policy purposes. At the time of the financial crisis, the GSEs included Fannie Mae,
Freddie Mac, the Government National Mortgage Association (Ginnie Mae), and the Federal Home Loan Bank
System (FHLBS), all of which were created by Congress to strengthen the availability of capital for home mortgage
489 See chart, below, using loan data from Inside Mortgage Finance.
490 See 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, at JPM_WM02405463,
Hearing Exhibit 4/16-86 (“At current level, alternative executions, e.g., Freddie Mac, FHLB, and private investors,
do not win a significant level of business.”).
491 See 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, at JPM_WM02405462,
Hearing Exhibit 4/16-86 (chart entitled, “Timeline of the Alliance Agreement”).
492 See 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, at JPM_WM02405461,
Hearing Exhibit 4/16-86 (“Under this Alliance Agreement with Fannie Mae, WaMu has agreed to deliver no less
than 75% of eligible, conforming loans to Fannie Mae.”); 2/23/2005 email exchange between David Beck and
WaMu executives, Hearing Exhibit 4/16-85 (“5 years of 85%+ share with Fannie”).
493 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, at JPM_WM02405459,
Hearing Exhibit 4/16-86.
494 Id. at JPM_WM02405467, Subcommittee Hearing Exhibit 4/16-86.
management, underwriting guidance, and support for WaMu’s Community Reinvestment Act
The following slide, created by Washington Mutual in March 2004, provides an overview
of the GSEs’ impact on the mortgage market at the time as well as the status of WaMu’s
relationship with Fannie Mae in early 2004.496
495 Id. at JPM_WM02405461, Subcommittee Hearing Exhibit 4/16-86. The Community Reinvestment Act (CRA)
was passed by Congress to encourage banks to make loans in low- and moderate-income neighborhoods. See
website of the Federal Financial Institutions Examination Council, “Community Reinvestment Act,” Regulators, including the Office of Thrift Supervision, periodically reviewed
banks’ CRA activities and took them into account if a bank applied for deposit facilities or a merger or acquisition.
Id. A 2005 presentation prepared by WaMu stated that its relationship with Freddie Mac helped the bank meet its
CRA goals by purchasing more than $10 billion in qualifying loans. See 9/29/2005 “GSE Forum,” presentation
prepared by WaMu Capital Markets, at JPM_WM02575611, Hearing Exhibit 4/16-91. Between 1991 and 2006,
WaMu was evaluated 20 times by OTS and the FDIC, achieving the highest possible CRA rating of “Outstanding”
in each evaluation. See website of the Federal Financial Institutions Examination Council, ratings search for
“Washington Mutual,” Regulations state that an “outstanding”
institution is one that not only meets the needs of its surrounding community, but utilizes “innovative or flexible
lending practices.” See 12 C.F.R. 345, Appendix A,
496 Id. at JPM_WM02405459, Subcommittee Hearing Exhibit 4/16-86.
Despite Fannie Mae’s long history with WaMu, in 2005, the bank made a major change
and shifted the majority of its conforming loan business to Freddie Mac. WaMu made the
change in part because its long term contract with Fannie Mae was up for renegotiation,497 and
Freddie Mac offered better terms. According to WaMu, Freddie Mac had purchased $6 billion
of its Option ARM loans in 2004, without a contract in place, and WaMu wanted to sell more of
those loans.498 WaMu conducted detailed negotiations with both firms that lasted more than six
months.499 Internally, it considered a number of issues related to switching the majority of its
conforming loans to Freddie Mac.500 The deciding factor was Freddie Mac’s offer to purchase
100% of WaMu’s conforming Option ARM mortgages which were among the bank’s most
profitable loans.501 In January 2005, in a document comparing the proposals from Fannie and
Freddie, WaMu wrote:
“The Freddie Mac Business Relationship [proposal] dated 12/21/2004 establishes another
execution opportunity that diversifies WaMu’s execution risk and confers material
financial benefits for the Option ARM product. The key to the Freddie proposal is that it
provides significant liquidity for our Option ARM originations, with more advantageous
credit parameters, competitive g-fees and preferred access to their balance sheet relative
to our current agreement with Fannie. Fannie has made it very clear to us that we should
not expect to retain the same pricing and credit parameters for Option ARMs in our 2005
pricing agreement that we have enjoyed during 2004. For fixed rate loans and hybrids, gfe[
e]s adjusted for MAP Pricing and credit parameters are roughly equivalent to the
Fannie Agreement.”502
497 See 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, at JPM_WM02405468,
Hearing Exhibit 4/16-86.
498 See, e.g., 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85
(reporting that Freddie Mac was “very aggressive in 2004 buying 6B of option arm without a share agreement in
499 See, e.g., 4/12/2004 “Pre-Meeting for Fannie Mae,” internal presentation prepared by WaMu, Hearing Exhibit
4/16-86; 12/17/2004 email exchange among WaMu executives, “Risks/Costs to Moving GSE Share to FH [Freddie
Mac],” JPM_WM05501399, Hearing Exhibit 4/16-88; 1/5/2005 “Business Relationship Proposal Issues,” document
prepared by WaMu, Hearing Exhibit 4/16-90 (describing multiple issues negotiated with both firms);
2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 (David Beck wrote:
“Fannie negotiated hard for our business especially in the 11th hour.” CEO Killinger responded: “Good work
David. It appears we got a good economic outcome and haven’t burnt any bridges for the future.”).
500 See 12/17/2004 email exchange among WaMu executives, “Risks/Costs to Moving GSE Share to FH [Freddie
Mac],” at JPM_WM05501401, Hearing Exhibit 4/16-88 (listing multiple issues including whether Fannie Mae
would “be less supportative [sic] of using their balance sheet to support our quarter-end liquidity needs”).
501 Id. at JPM_WM05501399 (describing Fannie Mae’s offer to purchase two-thirds of WaMu’s Option ARM
production); 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 (“I
reviewed the most recent proposals from Freddie and Fannie today with Steve. We agreed that the Freddie 65%
minimum share (100% of option arms) proposal offers us between 26MM and 37MM of benefit depending on
volume… 39% of our 2005 home loans gain on sale comes from conforming option arm sales. FH [Freddie Mac]
stepped up with 21B of committed balance sheet and aggressive forward pricing for OA [Option ARMs] that result
in the financial benefit over FN [Fannie Mae].”). WaMu originated both conforming and nonconforming Option
ARMs, depending upon whether the loan exceeded the GSEs’ dollar limit for the loans they would purchase.
502 1/5/2005 “Business Relationship Proposal Issues,” document prepared by WaMu, Hearing Exhibit 4/16-90.
In April 2004, at the conclusion of its negotiations with Fannie and Freddie, WaMu
entered into a one-year contract with Freddie Mac, switching the lion’s share of the bank’s
conforming loans to that company and away from Fannie Mae.503 According to WaMu, Freddie
Mac’s share of its conforming loans “went from 20% in Q1 [first quarter of 2005] to 81% in Q2
[second quarter of 2005].”504 WaMu reported internally that, as a result of the new contract, it
became the second largest seller of mortgages to Freddie Mac behind Wells Fargo, and that
“[f]orty percent of FRE’s [Freddie Mac’s] portfolio growth in ’05 can be attributed to WM’s $8
billion sale of option ARMS.”505
As the 2005 contract’s expiration date neared, WaMu developed a list of issues to be
negotiated with Freddie Mac for a new contract, noting that Freddie Mac “does not want to be a
‘one-year’ wonder.”506 WaMu also observed that “FRE is not likely to outbid FNM by such a
wide margin on option ARMS like in the current contract.”507 In a list of “asks … to cement our
relationship” with Freddie Mac, WaMu indicated, among other issues, that it would press
Freddie Mac to buy more subprime and “lower quality loans”:
WM [WaMu] wants FRE [Freddie Mac] to expand the eligibility of lower
quality loans to ensure WM is ‘market competitive’. …
Potential securitization of SMF [Specialty Mortgage Finance] assets ($1.5 -
$10 bil) that will create liquidity for WM and create a positive affordability
profile for FRE;
Expansion of credit profile into subprime; (Keith Johnson wants to keep this
point very general); …
Liquidity – we want to understand how we can best help the FRE portfolio
Longer term portfolio commitment on option ARMS;
Broader deliverability guidelines w/respect to option ARMs.”508
WaMu wrote that it also expected Freddie Mac to discuss trends related to accepting “lower
documentation standards.”509
In April 2006, WaMu signed a new, two-year contract with Freddie Mac, again agreeing
to sell the majority of its conforming loans to that company.510
503 See 7/5/2006 “Freddie Mac – WaMu Meeting,” document prepared by WaMu, JPM_WM03200453, Hearing
Exhibit 4/16-87 (“WM executed a majority share arrangement w/FRE [Freddie Mac], effective 4/1/05 thru 3/31/06;
included in that arrangement was a market-leading opportunity to sell up to $21 billion of option ARMs to the FRE
WaMu President Steve Rotella
504 Id.
505 Id.
506 Id.
507 Id. at JPM_WM03200453.
508 Id. at JPM_WM03200452-453 [italics in original omitted].
509 Id. at JPM_WM03200454.
wrote: “Congratulations to the team for getting this done and with terrific results for the
company.”511 In a document describing the “highlights” of the new agreement, a Wamu
employee wrote:
“Aligns WM with the stronger GSE over the next 12-18 months; we fully expect once
FNM [Fannie Mae] gets its financial house in order to become a very aggressive
competitor – just when this contract is coming up for renewal.”512
WaMu’s reference to the “stronger GSE” was in response to accounting scandals that,
over the prior year, had weakened both Freddie Mac and Fannie Mae. In 2003, Freddie Mac
announced that it had misstated its earnings by at least $4.5 billion, mostly by under-reporting its
earnings in order to smooth the volatility of its quarterly earnings reports, and would be restating
its earnings for the prior three years.513 Later that year, Freddie Mac paid a $125 million civil
fine to settle civil charges of accounting fraud brought by its regulator, the Office of Federal
Housing Enterprise Oversight (OFHEO).514 In September 2004, OFEHO issued a report finding
that Fannie Mae had also violated accounting rules to smooth its earnings reports.515 Fannie Mae
later filed a $6.3 billion restatement of earnings and paid a $400 million fine.516
When asked at the Subcommittee hearing to define Washington Mutual’s relationship
with Fannie Mae and Freddie Mac, Mr. Rotella provided the following response:

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