I've been periodically blogging the WAMU hearings in the Senate Committee on Homeland Security and Government Affairs. Below is my original blog from this morning. I've continued the blog here and here.
Former WAMU executives are about to appear before the Senate Homeland Security and Governmental Affairs Committee. The hearing is on CSPAN 3 now. The Committee just completed its initial investigation and found widespread fraud in additional to negligence and a general disregard for good underwriting practices.
I was watching a bit of CNBC last night and heard from Larry Kudlow (also reported in Forbes) that among the WAMU practices was fraudulent documentation creation. Forget no doc loans, loans that did not require a borrower produce any credit documentation--the sort of loans that destroyed Broadway Bank. According to Kudlow's report on the Senate Committee's investigation, if a WAMU borrower didn't have financials that showed he or she had the credit required for underwriting, WAMU employees simply altered the documentation or created new and acceptable documentation. They actually cut and paste bank statements to create acceptable financials for borrowers. The Senate Committee is diplomatically calling it "shoddy lending practices," but it's just plain old fraud.
In addition to simple, common criminal fraud, WAMU steered borrowers into loans that were more expensive than their credit required. These more expensive loans were more profitable to WAMU, but they were also more risky because the loans often had teaser rates with large increases after a set period of time or large balloon payments. They took people who could have probably paid on a conventional loan and turned them into deadbeats on loans that should never have been made.
Then, WAMU went ahead and bundled these fraudulent and risky loans along with some loans already in default and sold them on the secondary market.
I've always wondered what made the average corporate employee engage in bad practices and outright fraud. Sometimes its just ignorance of the law and lack of understanding. However, it seems impossible to me that someone cutting and pasting financial documents together does not know they are doing something wrong. So what drives people to do something like that? At WAMU, one possibility is the lender's compensation structure. The compensation structure encouraged high risk loans rewarding loan officers for steering borrowers into expensive, high risk loans. While the loan officers in the field made more money on expensive, high risk loans, their bosses, the middle managers, received huge bonuses on the bad loans. I have little doubt that there was a lot of pressure put on employees to make the bonuses for their managers. The highest ranked managers continued to collect large bonuses long after their bad practices pshed the lending institution over the edge.
WAMU's internal auditors knew there was a problem and did nothing. Worse is that the bond rating services rated the securitized loan bundles as tripple A investments. (See here and here) Worst is that the OTC knew all about it and did nothing until the situation became so bad it was impossible to hide.
What we have hear is a failure of leadership. Leaders at WAMU rewarded fraud and reckless disregard of sound underwriting practices. Managers at WAMU pushed employees to make more money for them by just about any means. Regulators wanted to be buddies with WAMU executives and did nothing about known risks. The republican Congress and Bush Administration did nothing because it was the free market they sought. Tom Coburn of OK, making his introductory comments in the hearing, just blamed Congress for not doing its duty on oversight. Mark Kirk was a member of that do nothing Congress and now he thinks he has something to say about mortgage fraud.
UPDATE 1: I'm hearing a lot of blame the borrower so far. James Vanasek, a former executive vice president at WAMU, just said that the borrowers didn't care because home values were going up. What he failed to menion is that the problem lending practices artificially increased home values. Loans were easy to get and appraisers were increasing values on demand of the lenders. The increased home values were never sustainable and people in his position should have known that.
In the IL-10, the artificially increased home values made it difficult for people to find housing. Existing homes were inflated by sellers profit expectations and builders had incentive only to build large, luxury homes. No one was building simple affordable homes like the one I grew up in when lenders only lent what a borrower could afford. People who worked in our area could not find affordable housing in the area putting pressure on our highway and public transportation systems that no one wanted to fund with additional taxes. District resident's children had to move far away because they could never afford a Tenth District home. I wrote about the problem years ago. Lending practices like the ones used at WAMU had long term severe effects on our neighborhoods. This was not a victimless crime.
Now Ronald Cathcart, former Chief Risk officer of WAMU, is making his opening comments. Somehow he's managed to refer to the problems in the third person as if he was a simple observer of the problem. The problems just happened, the conditions in the market made them happen. He had nothing to do with it.
UPDATE 2: "Ineffectiveness of fraud detection tools." That's what they're talking about, ineffective tools. It's as if there were no people involved. It's the tools fault. One big problem we have in this country is making anyone accountable. It's not the fault of people, it's the tools fault.
The auditors were just asked why they didn't clean anything up. Answer, not my job. Auditors just report. It's not their job to fix the problem. They could have whistleblown. They could have quit.
UPDATE 3: Now, we're hearing about "employee fraud" from Mr. Cathcart. As I said before, I suspect employees were pressured to do it. They were certainly incentivized to do it. I have no doubt that many employees were culpable, but they were also incentivized, induced and pushed to make these loans. When do WAMU executives have to take responsibility for the system they created?
UPDATE 4: Vanasek is talking about his impassioned internal pleas for WAMU to stop its underwriting and lending practices and he did leave at some point. I'm only wondering why he didn't do more to warn the country of the problems and the risks.