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Huzzah! FDIC Grows a Pair, Sues Ex-WaMu Execs for Recklessness

Kudos to the FDIC for taking legal action today against Washington Mutual ex-CEO Kerry Killinger and other former top execs of the defunct savings and loan. The company collapsed in 2008 in what is by far the largest bank failure in U.S. history.

In a civil lawsuit seeking total damages of $900 million, the banking agency accuses the executives named in the suit, including former WaMu president David Schneider and former COO Stephen Rotella, of focusing on enriching themselves while recklessly ignoring the financial risks facing the thrift.

Under their management, WaMu embarked on a real estate "lending spree" in the years leading up to the financial crisis despite recognizing that a housing bubble endangered the company, the FDIC alleges. WaMu leaders drove that growth by pushing the S&L deeper into the business of issuing risky subprime loans, according to the suit:

This relentless push for growth was exemplified by WaMu's advertising slogan, "The Power of Yes," which promised that few borrowers would be turned away....

Defendants knowingly pushed their higher-risk lending strategy at a point in the housing cycle when prices were unsustainably high. WaMu focused its growth in a few geographic areas -- notably California and Florida -- where housing prices had escalated most rapidly and were most at risk for significant decline. Defendants thus gambled billions of dollars of WaMu's money on the prospect that the bank somehow would manage to avoid losses on higher risk loans to high-risk borrowers in high-risk areas, despite their own awareness of the inevitable decline in the overheated housing market.

Missing "risk chromosome"
The FDIC said the three bankers were all highly experienced and knew that they were taking enormous risks in building up WaMu's subprime business. The execs were also aware that many borrowers who took out such loans were likely to default when home prices fell. Indeed, the three ignored warnings from WaMu's own risk managers that the company was issuing loans that homeowners would be unable to repay.

The execs also misled WaMu's board by claiming that they were properly managing and pricing for the risks associated with the company's dive into subprime lending. The suit states:

As the bank's chief risk officer told Killinger just weeks before WaMu went into receivership, the Bank's "DNA" was missing "the risk chromosome."
Dodging creditors
Between January 2005 and September 2008, when WaMu was seized by bank regulators and later sold to JPMorgan Chase (JPM), the three executives collectively received more than $95 million in compensation. As the S&L's losses mounted in 2008, Killinger and Rotella took steps to shield their wealth from future claims, according to the FDIC:
In or about August 2008, Kerry Killinger transferred an undivided one-half interest in his residence in Shoreline, Washington, to his wife, Linda Killinger. Shortly thereafter, Kerry Killinger and Linda Killinger each transferred their respective undivided onehalf interests in this residence to two irrevocable QPRTs named the "KK QPRT II 2008 Trust" (which appointed Kerry Killinger as trustee) and the "LCK QPRT II 2008 Trust" (which appointed Linda Killinger as trustee). Each of these property transfers was made with actual intent to hinder, delay or defraud Kerry Killinger's present and future creditors.
Admission of guilt?
Killinger issued a statement denying the allegations and dismissing the suit as "political theater." He also decribed WaMu's management as a "model of corporate governance," while arguing that federal regulators were well aware of the company's business model.

As the suit notes, however, the exec admitted in a June 2008 memo that that the thrift had "overinvested" in mortgage lending and that expanding its subprime lending portfolio had made the business more complex and volatile. Killinger wrote at the time:

In hindsight, these products were expanded with too much dependence on appreciating home values and underwriting that followed secondary market guidelines.
Even if these charges are civil, rather than criminal, it's heartening to see the feds acting to punish bankers who had a direct hand in the financial crisis. Hats off to FDIC chairman Sheila Bair.

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