President Obama is meeting with Congressional leaders right now about Wall Street reform. He should use this week's revelations about the depth of existing bank regulators’ failure to crack down on a Washington Mutual business model built on predatory consumer lending to urge lawmakers to commit to an independent consumer financial regulator.
Yesterday marked the first of four planned Senate hearings by the Permanent Subcommittee on Investigations into the nation's largest bank failure, Washington Mutual. The day was marked by revelations that the company chose to focus its lending operation on high risk mortgages because they offered greater profits, offered financial incentives to employees based on quantity and higher risk loans, and steered borrowers into loans they could not afford, in order to package and sell them to investors as mortgage backed securities. Check out a great live blog here, from Zach Carter at the Campaign for America's Future.
WaMu knowingly pushed people into predatory option-ARM loans. Option-ARMs are some of the worst loans issued during the housing bubble-- they have an incredibly low montly payment for a few years, so low that the borrower doesn't even pay off the interest on their loan. After a couple of years, the monthly payment explodes-- often doubling or tripling-- and the loan becomes totally unaffordable.
WaMu actively trained loan personnell how to encourage skeptical borrowers to take these predatory loans out. There was a reason for this: when option-ARMs were packaged into securities, they fetched a very high yield, meaning they were very profitable for the bank. So WaMu could make bigger short-term profits from issuing option-ARMs than it could from issuing an ordinary 30-year prime loan.
And WaMu encouraged its loan officers to push these loans, by rewarding officers with compensation schemes that were tied to the number of loans sold, not the quality of the loans. That compensation scam went all the way to the top. WaMu CEO Killinger made $11 - $20 million a year during the housing bubble, all while running a company whose business model was based on fraud and predation.
Washington Mutual made predatory lending its business model and bank regulators did too little too late to crack down, just as they failed to rein in the same kind of risky and abusive lending at banks across the country. It's just the latest in a long list of examples of why we need a truly independent regulator whose job it is to protect consumers and the economy from fraudulent and abusive lending, even when everyone would rather bet the farm that they can ride riskier and riskier bets to huge profits. Without that independence, we can count on regulators continuing to give consumer lending abuses second-shrift until problems are too big too ignore, or fix.
As reported by Senate investigators, Washington Mutual’s internal bank reports show the bank failed to comply with its own lending standards. A 2005 internal review of loans found widespread fraud, including a rate of 58% of the loans coming from one top loan officer’s operations and 83% from another.
A strong consumer regulator would have been actively fielding complaints from the public that would have tipped them off to the problems at Washington Mutual. A regulator whose only focus was consumer protection would have acted more quickly to question WAMU’s rapid shift from traditional 30-year fixed rate mortgages to a business focused on abusive no-doc, interest-only and zero down subprime lending. I’ll go out on a limb to say that lending that encouraged people to lie about their income so they'd end up in forclosure would have been frowned upon by a consumer regulator. And we would have likely seen investigations into salary and bonus incentives tied to packing loans with higher fees or steering prime-qualified borrowers into riskier packages.
How badly did banking regulators ignore these red flags? The fact that OTS continued to rate the bank “fundamentally sound" until early 2008, just seven months before WaMu’s collapse, says that they ignored them until it was too late. We’ll know more on Friday, when committee hearings continue and part II of the investigation, a focus on regulatory failings, is expected to be released.