Liveblogging the Washington Mutual hearing

4:25

Levin is ripping Killinger on option-ARM delinquencies. WaMu performed a study concluding that option-ARMs were about to default like crazy, and right after that study, WaMu started pushing option-ARM securities hard to investors. The company sold a $3 billion batch of these securities on an \”urgent\” basis, according to internal emails, which is a pretty big deal to ram through for a company of WaMu\’s size ($300b). Killinger is pleading that he didn\’t know the details of that securitization, and he\’s saying he doesn\’t know if it would have been appropriate to tell investors that the company had done

\”I don\’t know what actually happened,\” Killinger said.

Killinger is trying to dance around criminal charges. If he acknowledges that something should have been disclosed to investors that was not, in fact, disclosed, it will be very hard for him to pass the buck in court. He was the company\’s CEO. His job title and his epic paychecks mean that he is ultimately responsible for everything. If he ever acknowledges that the company messed up its disclosures, he\’s almost certainly on the hook for negligence.

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3:30

Wow. This is making me nauseous. Killinger is talking about how bad he felt about laying off thousands of people, and the effect this would have on their families.

Interestingly, no tears for the thousands of foreclosures Killinger needlessly caused.

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3:25

Killinger is now saying that regulators didn\’t treat the company with \”the same equal handed and fair manner\” that other financial instituitons received, and said his company would have survived had it not been placed into receivership.

First, this is crazy.

Second, Killinger\’s rationale is doesn\’t make sense. He\’s saying the company died because liquidity dried up, and the firm went under before the government\’s liquidity operations kicked in. Liquidity didn\’t kill Washington Mutual. Massive, massive losses from bad mortgage lending killed Washington Mutual.

Killinger argues that because lots of other banks got bailed out via TARP and various government-blessed mergers, WaMu should have been bailed out too. But WaMu was exactly the kind of company that didn\’t deserve to participate in rescue operations. It was engaged in reckless lending, it pushed outrageous, predatory products and coached its loan officers to convince borrowers into taking out loans that were not appropriate for them, especially option-ARM loans. It\’s securitization operations were wildly fraudulent. Washington Mutual was a textbook predatory lender that served no other useful social purpose.

Now, plenty of banks that were saved should not have been. And no banks should have been bailed out under the generous terms the U.S. government offered. But the fact that too many banks were saved doesn\’t mean Washington Mutual should have been one of them.

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3:15

So now we\’ve got COO Stephen Rotella and Chairman and CEO Kerry Killinger testifying.

Rotella just claimed he never knew about fraud until 2008, but oops! he misspoke. He didn\’t know about a particular fraud until 2008. He knew about another fraud when the company did an audit in 2007.

Levin is now detailing the kinds of fraud that were perpetrated in the origination arm. In one loan, a man who was employed as a signmaker supposedly made $34,000 a month. When WaMu tried to get the loan insured by Radian (an AIG FP-type company), Radian refused, because it was crazy to think that you could make $400,000 a year from making signs.

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2:15

So far we have two major allegations of misconduct in the securitization shop. One, is that WaMu knowingly sold fraudulent loans to investors in the form of securities.

Two, is that WaMu expected a certain class of loans– option-ARMs– to have heavy delinquencies in the coming months. But instead of dropping the option-ARM business, the company tried to jam as many option-ARMs as possible through its securitization machine before markets figured out that the securities were junk. They not only packaged existing option-ARM loans into securities, they issued as many new option-ARMs as possible, in order to score securitization profits before the market collapsed. WaMu even conducted a study on option-ARM delinquencies, determined that they would be incredibly high, and didn\’t tell its investors that the company expected those option-ARMs to go bad, and by extension, the option-ARM securities.

This is very similar to what Goldman Sachs did with its production of synthetic subprime CDOs– a private company scoring profits by setting its investors up for a fall (in Goldman\’s case, they were going a step further, creating the synthetic CDOs not only so they could sell them, but so they could bet against them).

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1:50

Internal WaMu audits found that the company\’s loans were fraudulent. But even after those loans were explicitly determined to be fraudulent, WaMu still decided to sell them to investors in the form of securities. It\’s not just that the company figured out loans they had already securitized were fraudulent, but that they knowingly sold fraudulent loans to investors.

Beck is pleading that he didn\’t know about the fraud audit. That requires quite a stretch of the imagination. He headed the capital markets group. He was in charge of securitization. It\’s just unthinkable that the company wouldn\’t tell him about this problem. But whatever the truth, it\’s terrible for the company. If they didn\’t tell him, Beck\’s supervisors are guilty of gross negligence, at best. If they did tell him, and he didn\’t do anything about it, they\’re still guilty of gross negligence. There\’s nothing Beck or his bosses can say to exonerate themselves.

This is how the mortgage business worked. In the go-go-go years, nobody anywhere cared about loan quality, and nobody cared about fraud. Levin\’s panel should conduct similar investigations into every major banking conglomerate that survived the financial crisis. My guess is there would be plenty of similar stories to those we\’re hearing today.

Sadly, Congress probably doesn\’t want to go after Wall Street firms that are still paying high-powered lobbyists.

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1:45

David Beck, WaMu\’s securitization chief, says he never saw the company audits indicating widespread fraud. If true, that would insulate him from personal charges of misconduct, but implicate the company\’s executives for failing to notify its securities shop about the fraud.

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1:35

This is amazing. Levin is citing internal WaMu docs indicating that the employees under internal fraud investigation were given all expenses paid trips to Hawaii and the Bahamas as a reward for their high-output.

Let me say that again. WaMu sent employees it was investigating for fraud on luxury trips to Hawaii and the Bahamas.

What\’s more, employees who were ultimately fired for engaging in fraud were offered other jobs with the company. Astounding stuff. But contemporary finance is all about being rewarded for failure. None of the executives at any of the bailed out banks were forced out of office as a condition of their bailouts. The one major executive who has stepped down– Bank of America CEO Ken Lewis– left with a massive, $50-plus-million-dollar pay package.

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1:30

Levin is on a roll. He\’s pressing WaMu home loan president David Schneider about his actions following internal company reports about fraud in his division. He says the people who admitted to committing fraud were fired. But Schneider admits that he never follwed up with WaMu\’s legal department to determine whether the company tried to notify investors who bought the mortgage backed securities comprised of fraudulent loans.

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12:50

Pay attention to David Beck\’s testimony. He\’s the guy who ran WaMu\’s securitization shop. This is where the repeal of Glass-Steagall had an effect on WaMu\’s business model. Basically, WaMu\’s origination team (the commercial bank) became slaves to the securitization team (the investment bank). One arm of the company issued bad loans in order to package them into profitable securities for another arm of the company. The prospect of booming investment banking revenues encouraged the commercial bank to do reckless things. That\’s why ending the separation between investment banking and commerical banking was a big mistake.

Now, WaMu could have sold the loans to other Wall Street investment banks for securitization. This is what subprime lenders like New Century and Ameriquest did. And that would have been a problem with or without the Glass-Steagall repeal. But it\’s not obvious that Washington Mutual– an enormous mortgage firm with a long history of boring, plain-vanilla mortgage lending– would have totally converted its operations to subprime and alt-A insantiy without the lure of in-house securitization profits.

Bankers really want to protect their investment banking revenues, because they\’re what make money when the economy is terrible. All of the major banking conglomerates like JPMorgan Chase and Bank of America are taking a beating on their business that are tied to the real economy– mortgages, credit cards, etc. But their fancy investment bank securities trades are doing very well. So there has been a tremendous lobbying push to defend the Glass-Steagall repeal. JPMorgan Chase CEO Jamie Dimon likes to highlight that both investment banks and commercial banks had problmes in the crisis, but that argument is basically irrelevant. The fact that different types of firms made mistakes doesn\’t change the fact that some firms made mistakes because of the repeal (among them Wells Fargo, JPMorgan Chase and Bank of America).

Repealing Glass-Steagall may not have been the only factor leading to the crash, but it was certainly a significant one.

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12:30

I hope members of the Financial Crisis Inquiry Commission are taking notes on this hearing.

Levin et al are presenting evidence of wrongdoing, and asking a direct questions about accountability. The FCIC would treat these guys like experts from the industry whose opinions are truly valuable, rather than people who need to answer for screwing up. The FCIC\’s job isn\’t to decipher every techincal dimension of the meltdown and present a long-winded report for bankers who already know what went wrong. It\’s job is to distill the crisis into a handful of basic problems and communicate those to the public.

This WaMu hearing is doing a terrific job highlighting how excessive and poorly designed pay packages fueled the crisis and encouraged rampant fraud. That\’s a very important dimension to the problem, and one that resonates with the public. There\’s something fundamentally unfair about Kerry Killinger becoming a megamillionaire for running a fraud machine that wreaked havoc on the economy.

Granted, nobody defends WaMu these days, not even the financial press, so they\’re an easy target for politicians on both sides fo the aisle. But I did not come away from a single FCIC panel with a clear, distilled understanding of what they were trying to communicate.

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12:15

Fraud on Fraud. Coburn is asking the panelists whether the massive fraud in WaMu\’s mortgage origination business had a \”material adverse\” effect on the company\’s prospects. That\’s important, because if it really was a material adverse issue, SEC regulations would require WaMu to disclose the mortgage fraud to its investors. Of course, WaMu never disclosed it, which means– if the mortgage fraud was \”material\”– WaMu committed securities fraud by failing to tell investors.

This is not a left-right, progressive-conservative issue. Any conservative should value fair play and basic market transparency. WaMu shows that the U.S. financial system basically didn\’t have any of that for a very long time.

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11:45

Cathcart said the \”drying up of liquidity\” in 2007 was the first real sign that the company was headed for big trouble. That\’s an important point for the Wall Street reform bill currently being considered in the Senate. All three of the WaMu guys talking right now were aware that the business was rife with fraud, but Cathcart was saying that so long as they had access to cheap funding, he didn\’t think they would go over a cliff.

This matters because the \”drying up of liquidity\” in 2007 wasn\’t a minor event. It was a massive credit crunch that shook the financial system to its very core. Banks were able to survive on false optimism for about a year, so you didn\’t see major failures until 2008, but by 2007, the crisis was in full swing.

This a very good argument for breaking up the big banks. Strengthening capital requirements and liquidity requirements alone won\’t be enough, because nobody will know how much capital and liquidity is needed until it\’s too late. You have to protect the system against a scenario in which everybody screws up– bankers and regulators alike. If a bank\’s failure could jeopardize the entire financial system, policymakers will find some legal justification for propping it up. In that scenario, giant banking behemoths will not be allowed to fail. Even if regulators get the \”resolution mechanism\” being contemplated by the Dodd bill, they won\’t use it.

The only credible way to deal with this problem is to put a cap on bank size and activities, so that banks can actually fail without wreaking havoc on the economy.

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11:15:

Vanasek said he was not surprised at the level of fraud found in WaMu lending, and he wasn\’t suprised that the audit concluded the fraud was a result of the \”willful\” actions of WaMu employees. And, indeed, it was.

There are two types of financial outrages: things that are outrageously illegal, and things that are, outrageously, legal. So far, this hearing is all about the first category.

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