The FDIC’s WaMu suit

By Felix Salmon
March 17, 2011
complaint against various WaMu officers makes for fascinating reading. I've embedded it below.

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The FDIC complaint against various WaMu officers makes for fascinating reading. I’ve embedded it below.

One thing that jumps out from the complaint is the enormous amount of very clear documentation here that the WaMu officers in question, up to and including Kerry Killinger, not only knew exactly what they were doing all along, but were very clear about it. They embarked upon an explicit strategy of increasing risk, by writing new mortgages, by concentrating on subprime, and by concentrating geographically. They were aware of the downside risks involved, and they went ahead with the strategy regardless. At the same time, they were very dismissive when it came to risk management.

There’s no indication whatsoever that the officers tried to hide what they were doing from their board or their regulators, or that they thought it was in any way wrong or illegal.

If the risks they took paid off, they would have been hailed as heroes, and the FDIC would have no problem with their behavior. There certainly wouldn’t have been a lawsuit like this one, since the FDIC has to show that it suffered damages before it can bring it.

I don’t like the idea of criminalizing failure. Banks by their nature are leveraged institutions which are vulnerable to runs and to declines in their asset values. There’s always a natural tension between managers, who are looking to maximize profits, and regulators, who are looking to minimize risks. But in this case there’s no indication that WaMu’s regulators, including the FDIC, expressed any concern about Killinger’s strategy. If they were OK with it, at the time, it’s easy to see how the executives considered that a green light to go ahead and implement it with gusto.

But at the same time, it’s unconscionable that these guys should be able to get away with what they did just because they did it out in the open, in front of supine regulators. They knew that they were too big to fail; they knew that ultimately WaMu’s liabilities (or at least its deposits) were being backstopped by the US government; and they knew that if they wanted to get their total compensation up into the $100 million range they were just going to have to take enormous risks and gamble with the money they had essentially unlimited access to at the Fed’s discount window.

Bankers have to be held to some kind of standard. And the standard put forward here, by the FDIC, in paragraph 184, seems a reasonable one to me. Indeed, it’s so clear and reasonable that it’s worth quoting in full:

As officers and/or directors, Killinger, Rotella and Schneider owed WaMu a duty of care to carry out their responsibilities by exercising the degree of care, skill and diligence that ordinarily prudent persons in like positions would use under similar circumstances. This duty of care, included, but was not limited to, the following:

a. To adopt such careful, reasonable and prudent policies and procedures, including those related to lending and underwriting, as required to ensure that the Bank did not engage in unsafe and unsound banking practices, and to ensure that the affairs of the Bank were conducted in accordance with these policies and procedures;

b. To communicate to the Bank’s loan officers and underwriters a clear expectation that they must adhere to sound lending policies and credit procedures by establishing a system of checks and balances and by careful monitoring of loan officers’ conduct;

c. To require that sufficiently detailed, current and reliable information be provided upon which they could make prudent decisions, including the use of current technology and internal control procedures to timely identify problems and allow for early remediation;

d. To support and foster WaMu’s internal risk management functions, and ensure adequate funding for these functions for a Bank of WaMu’s size and assets;

e. To develop contingency plans and take other proactive steps to limit or prevent significant financial losses in the held-for-investment single family residential home loans portfolio;

f. To consider and adopt reasonable recommendations from employees of WaMu’s Enterprise Risk Management department for controlling the Bank’s lending risks;

g. To timely acknowledge and adequately respond to changes in economic conditions that create additional risk with respect to certain types of products or transactions;

h. To enforce policies and procedures designed to ensure that loans would not be made based on inadequate or inaccurate information;

i. Upon receiving notice of an unsafe or unsound practice, to make a reasonable investigation thereof and to exercise reasonable business judgment with respect to all facts that a reasonable investigation would have disclosed;

j.   To carefully review reports of examinations and other directives of regulatory agencies, to carry out the instructions and orders contained in those reports, to investigate and cure problems noted therein, and to prevent any repetition of such problems and deficiencies; and

k.   To conduct WaMu’s business in compliance with all applicable state and federal laws and regulations.

To be sure, a lot of this is 20-20 hindsight vision. But at the same time, it’s basic common sense, and highly-paid bank executives should live and breathe this stuff every day. The fact that WaMu’s executives failed to do so was a significant contributor to a global financial crisis for which, to date, no senior executives have been found responsible at all.

This is by no means a cut-and-dried case, and I suspect that the FDIC will be more than willing to settle with the directors’ insurers before trial. The FDIC has always been particularly vindictive when it comes to WaMu, for reasons I don’t pretend to understand — something which comes out in this complaint when they decided to make the executives’ wives named defendants. It would be great, too, if the FDIC admitted it fell down on the job in terms of regulating WaMu in 2005-8.

Still, I’d like to see more of this kind of thing, rather than less. If only because that way it wouldn’t look like WaMu and its executives were being singled out. Where’s the equivalent suit, for instance, against Stan O’Neal?

Update: Here’s Steve Rotella’s response.

FDICsuit

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