WaMu Bank Executives Knew of Rampant Fraud, Yet Failed to Act

One of the central unanswered questions of the financial crisis is whether bank executives knew fraud was rampant within their mortgage loans.

A Senate committee will present evidence that in the case of Washington Mutual Bank, the largest bank failure in history, executives knew about the fraud -- and in some cases failed to take much corrective action. By doing nothing, the bank could report higher profits and employees could earn higher bonuses.

So far no criminal charges have been brought against any senior executives as a direct result of the subprime meltdown. And on Tuesday Sen. Carl Levin, the Michigan Democrat who will chair the hearing, sidestepped questions about whether Washington Mutual executives broke criminal laws.

But Levin’s committee has unearthed documents that show that in 2005, WaMu’s own internal investigation of two top-producing offices making loans in southern California found that fraud was out of control. At one office in Downey, Calif., 58 percent of mortgages were found to be fraudulent. At an office in Montebello, Calif., the rate was even higher: 83 percent.

Yet “no steps were taken to address the problems, and no investors who purchased loans originated by those offices were notified in 2005 of the loan problems,” Levin's Permanent Subcommittee on Investigations stated in a report released in advance of the hearing.

Some problems persisted two years later. A follow-up internal review of the bank's Montebello operation, in 2007, still found a fraud rate of 62 percent.

The results of WaMu's 2005 internal investigation were sent directly to David Schneider, president of Home Loans. Sources close to the committee say Kerry Killinger, Washington Mutual’s president, chief executive officer and chairman at the time, knew about the internal reviews, but may have found out about them later than others.

Examples of fraud found included phony identifications for borrowers, buyers who acted as fronts for real buyers and  phony credit histories. An internal report concluded, "Throughout the process, red flags were over-looked, process requirements were waived, and exceptions to policy were granted."

A report by the Huffington Post Investigative Fund found similar problems, including reports that supervisors approved loans even after staff tried to raise red flags. The story detailed how management practices at Washington Mutual became an invitation for fraud. Within Long Beach Mortgage, former employees described how some sales people taught brokers how to break the rules, including using fake and forged documents.

The committee found evidence in one Long Beach Mortgage office that sales people sometimes cut and pasted borrowers’ names on false bank statements. As a result of shoddy lending practices, Washington Mutual had default rates on loans it sold to Wall Street as high as 57 percent on a subprime security it sold in 2007, the committee found.

Killinger and Schneider, as well as former president and chief operating officer Stephen Rotella, are scheduled to testify tomorrow. They are expected to say that they took steps to try to correct problems with their subprime loans. Killinger is also expected to say that his bank was on the mend and could have survived had regulators not shut it down in the midst of a run on deposit in September 2008.

In September 2008, Washington Mutual assets were sold to JP Morgan Chase for a pittance -- $1.9 billion for a $300 billion company. But WaMu had $188 billion in assets and regulators risked wiping out the FDIC’s $45 billion insurance pool it they hadn’t stepped in, a committee aide said.

Levin said Washington Mutual’s failure was caused by greed.

“They decided they would make more profits if they went for the high-risk loans,” Levin said. “We all paid the price.”