WaMu-CRA Link Pushed Down the Memory Hole

Washington Mutual (WAMUQ), which at one time was the sixth-largest depository institution in the U.S., became the biggest bank failure in U.S. history when it was seized in September 2008 and sold to J.P. Morgan Chase (JPM). Our legislators are now trying to figure out what happened, but still mystified: ‘Details Scarce on WaMu Failure’ reads today’s WSJ headline. In another WSJ piece, Senator Carl Levin notes:

WaMu had poor policies, poor controls, inadequate oversight of its loans, it turned out toxic mortgages that sunk the bank, devastated homeowners and polluted the financial system like a poison

But back when the seeds of the recession were being sown WaMu was ‘best practices’. The CRA gave activists veto power over bank mergers, so in 2003, when they took over Dime Bank, they bragged about pledging $375 billion towards funding low income borrowers at a time when their total assets were only $250B. They won the 2003 CRA Community Impact Award for such profligacy. The only way to shove that much crap thru is to lower underwriting standards. Thus, WaMu accepted a picture of a mariachi singer in his mariachi outfit as the sole documentation of his income.

James Lockhart, an executive at the Fannie Mae regulator notes in his written testimony that Fannie and Freddie were very concernded with meeting ‘affordable housing goals’ (newspeak for giving loans to people who can’t afford them), and made sure they met them. Further, they were actively appeasing Countrywide, who was a major customer of Fannie and Freddie.

It is important to remember that government legislators and regulators were encouraging reckless subprime lending the whole way down. Maybe they didn’t cause the crisis, or they were not even one of the larger of several causes, but they were not arguing for stricter underwriting standards during the height of subprime lunacy. Even today, the only place you can get a home loan with only 3.5% down payment is from the government’s FHA program.

So, when Armando Falcon, former chief regulator of Fannie and Freddie, who was on Capitol Hill Monday, suggests his problem was a lack of resources, remember, they had over 300 people looking at only two institutions, and were not saying anything about the novel, lower underwriting standards (eg, income verification, credit history, down payments, etc.). If they had 3000 people, they would not have done anything about the weakest link in their credit strategy.

Yet, the head of the Fannie and Freddie regulator continues to insist that “affordable housing goals” had absolutely nothing to do with their failure, because “The firms would not engage in any activity, goal fulfilling or otherwise, unless there was a profit to be made. Fannie and Freddie invested in subprime and Alt A mortgages in order to increase profits and regain market share.” Further, “OFHEO made it very clear to both enterprises that safety and soundness was always a higher priority than the affordable housing goals.” Yet there is no evidence they ever mentioned underwriting standards prior to 2007 as a concern. He seems to be saying that because these activities made money prior to 2007, and everyone was doing it, it was not risky. That’s like saying you are against hangovers, but saw no evidence of such effects while you were on you seventh beer, so your oversight did not encourage hangovers.

About Eric Falkenstein 136 Articles

Eric Falkenstein is an economist who specializes in quantitative issues in finance: risk management, long/short equity investing, default modeling, etc.

Eric received his Ph.D. in Economics from Northwestern University , 1994 and his B.A. in Economics from Washington University in St. Louis, 1987

He is the author of the 2009 book Finding Alpha.

Visit: Eric Falkenstein's Website

1 Comment on WaMu-CRA Link Pushed Down the Memory Hole

  1. The vast majority of subprime loans (over 80%) were made by firms not subject to CRA requirements. I challenge you to show the percentage of WaMu’s lending that was under its CRA obligations, and further, to prove that these loans were more likely to default than the other loans it was making. Otherwise, call your post what it is: a hatchet job.

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