Sense on Cents

What really happened at Washington Mutual?

With former Washington Mutual executives facing a Senate subcommittee today, all eyes and ears in Washington are focused on the lending practices and management of this failed thrift.

Did Washington Mutual knowingly originate fraudulent loans? Did WaMu reject mandates from regulators to change lending practices? Did the regulators themselves even know what was going on at Washington Mutual? All great questions deserving full and total transparency if America is ever to fully understand what happened on Wall Street.

I had personal experience with Washington Mutual both during my days at JP Morgan and then shortly after I departed JPM in 2006. Prior to my addressing that topic, let me share with you that Washington Mutual’s business model was a classic ‘originate to distribute’ plan. As they tried to build out their broker-dealer arm in the 2003-2008 era, they were trying to mimic the success that Countrywide had in developing its broker-dealer starting in the mid-90s.

In the early part of this decade, Washington Mutual went on a buying binge of smaller thrifts and mortgage originators across the country in an attempt to gain massive market share. Everywhere you looked, another WaMu branch was popping up.

As WaMu took over all of these other originators, though, I learned from first hand interactions that they were hamstrung in properly managing their risk. Why? They could not properly mesh or integrate all of the respective risk systems across the entire organization. The place was an absolute mess.

While attempting to clean up and address their back office problems, the WaMu front office continued to originate a variety of aggressive mortgage products, especially sub-prime mortgages and pay-option ARMs (adjustable rate mortgages).

Chase Home Finance, the mortgage origination arm of JP Morgan, had much stricter lending guidelines and Jamie Dimon was not about to literally risk the franchise by originating these products. While at the time Wall Street was making good money originating, securitizing, and distributing these products, Dimon had the vision to realize that the firms doing that business (WaMu, Countrywide, Lehman, Bear, Merrill) were taking enormous franchise risk in the process.

While WaMu did make some progress in developing its risk systems, they had no way of hedging their two greatest risks, those being reputation risk and exposure to housing in general.

Should regulators have forced WaMu to apply the brakes much earlier during their buying binge? No doubt. Did regulators understand these risks? Evidence indicates they did not. Evidence also indicates that WaMu executives did not understand the risks either.

Who did understand the risks? Jamie Dimon. He long desired WaMu’s branch network system, and he ended up getting it for an absolute song. In this case, to the victor went the spoils.

The rest is history.

LD

This entry was posted on Tuesday, April 13th, 2010 at 11:01 AM and is filed under General, Washington Mutual. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.