History – David S. Moore: Insights & Innovations

The Lost Bank: The Story of WASHINGTON MUTUAL, The Biggest Bank Failure in American History, by Kirsten Grind, was published in 2012. It’s written very much like a novel, with lots of in depth insight into the thinking and attitudes of many of the people involved in what was without question an unmitigated disaster.

I had followed the demise of WaMu casually at the time. I read the multi-part story of the collapse in the Seattle Times, and of course I was aware of the broader collapse of the real estate market across the country. But this book made me aware of dimensions of the WaMu story that I hadn’t previously understood.

For one thing, Washington Mutual was led in the 1980s by Lou Pepper, who fostered a code of behavior that was based on ethics, respect, teamwork, innovation, and excellence. The bank’s tag line was that it was a “friend of the family.” Lou Pepper believed in selling a good product at an honest price. Tell your customers the truth, be honest and forthright, and you’ll make lots of money. Pepper circulated through the company, talking to people in all levels of the business. Here’s how Ms. Grind put it:

He encouraged executives to dress up on Halloween, bringing candy to the branches. He regularly ate in the cafeteria on the second floor with everyone else. He sat with the building’s maintenance men so frequently that they presented him with his own work jacket. To employees, he really seemed like one of them.
The Lost Bank, pg. 20-21

The culture that Pepper built at Washington Mutual resonated with the company’s employees. They genuinely felt part of something, and they felt good about working for a company that was serving its customers honestly.

Pepper chose Kerry Killinger to replace him. Although Killinger was sharp and insightful, he was also distant and aloof. He could elicit details from a report that others might miss, but he found it difficult to make eye contact, or to initiate conversation, or to confront anyone about issues affecting the bank’s profitability. He tended to stay in his office, rather than to mingle. It just wasn’t his thing.

Troubles began to surface in 2003 when Fay Chapman, WMs chief legal officer, became aware of the underwriting guidelines of Long Beach Mortgage, a subprime lending subsidiary that had been purchased four years earlier. She learned of 270 loans sampled from those that had been sold by Long Beach, 40% were unacceptable because they contained a “critical error.” She demanded to do a more thorough review of Long Beach, and ultimately Killinger allowed her to take a team of about 100 people down to California to do an intensive review of Long Beach’s records. Here’s how Ms. Grind summarized Chapman’s findings:

By the end of three long months, Chapman’s team had reviewed 4,000 mortgages from Long Beach. Of those, only 950 were deemed good enough to be sold to outside investors. The rest were basically garbage. Even more troubling, several hundred loans had so much paperwork missing that Long Beach wouldn’t have been able to foreclose on a borrower in default. It wasn’t even clear who owned the mortgages anymore.
The Lost Bank, pg. 77

Thanks to Ms. Chapman’s efforts WM put a stop to the haphazard practices that had resulted in such a high percentage of garbage loans at Long Beach.

Under Killinger’s leadership, WM went on a buying spree. The bank purchased other banks at a frenetic pace, expanding Washington Mutual to become the largest savings and loan in the country. By 2007 Washington Mutual was sitting on assets of more than $300 billion.

Killinger was far more interested in growing the business than in staying true to the values and principles that had prevailed during Pepper’s tenure. He pushed the bank away from its old roots of just being a friend of the family to being far more sales oriented. He even said that everyone in the company was in sales. But in the course focusing chiefly on sales and less on company culture, the bank allowed poorly documented mortgages to take an ever increasing proportion of its portfolio.

WM had been selling ARMs (Adjustable Rate Mortgages) since the 1970s. In the early 2000s Option ARMs became a major part of the business. These were loans that gave the borrower the option of choosing the payment they preferred. A minimum payment was listed on the customer’s bill, but that minimum only covered interest, not the premium. Many of the banks that WM had purchased sold Option ARMs, so this type of loan became part of WM’s DNA.

Kevin Jenne, a WM manager in market research, conducted a number of focus groups of Option ARM borrowers. He quickly learned that borrowers didn’t understand what was adjustable about an ARM loan, or how it was adjusted, or when it was adjusted. Customers simply didn’t understand the terms of the loans they had purchased.

Jenne also found that many of the agents who were selling Option ARMs didn’t fully understand them either– and they therefore weren’t communicating to borrowers the full extent of their indebtedness.

Once the real estate market began to collapse, the logic behind the Option ARM collapsed as well. As long as real estate values were climbing, anyone with an Option ARM load could simply refinance based on the new, higher value of their property. Some borrowers were refinancing every six months! But once real estate values started to fall, that approach no longer made sense. The long term picture for WM, as for many of the other lenders in the country, was that the bank held an ever increasing percentage of mortgages that were almost certain to go into default.

Rumors began to spread that WM didn’t have the resources to cover the cost of loans that were almost certain to go sour as the market turned down. The government downgraded WM’s rating. There was a massive run on the bank between September 9th and September 25th 2007 during which time customers pulled over $16 billion out of their accounts. In the previous 9 months WM had also lost over $6 billion on bad loans.

Killinger was fired by the Board of Directors on September 4th, 2007. A new CEO was hired on Monday September 8th– Alan Fishman. He immediately dove into searching for a buyer for the company. But after a three week frantic search he was unable to find any buyers.

Behind the scenes the FDIC was talking to many of the same potential buyers that Fishman had approached. The FDIC put WM up for bid in a secret auction that was predicated on the idea that the FDIC would shut the company down, but would assume none of the debt carried by the bank. JPMorgan was the only bidder.

WaMu was shut down by the FDIC on September 25, 2007 and was sold to JPMorgan Chase for $1.888 billion. At that time WaMu had about $310 billion in assets. WaMu’s holding company, Washington Mutual Inc., filed for bankruptcy. That wiped out $7 billion in share value, $2 billion in preferred shares, and another $20 billion for bondholders.

The government and WM had different figures for the bank’s financial status at the time of its closing. The government said that WM had $20.8 billion in available liquid assets, but WM said the real number was $29 billion. Both numbers were above 5% of total assets, the normal point at which the government would force a bank to close. What is the source of the discrepancy? Here’s what Ms. Grind has to say about it:

WaMu’s liquidity figure on the day of its failure is unresolved, as is the difference between these assessments.
The Lost Bank, pg. 300

The end of the whole fiasco is extremely unsatisfying. As far as WM goes, most of the blame would properly fall on Killinger. He was warned several times of the danger that Option ARMs could pose to the long term health of the company– and he did nothing whatsoever to stop it. By contrast, Jaime Dimon of JPMorgan anticipated the devastation that Option ARMs could wreak– and he pulled JPMorgan out of that market.

Killinger was given a severance package of about $22 million. The FDIC sued him and two other WM executives for $900 million. The case was settled in 2011 for $64 million. But the damages assessed were paid from WM’s insurance policies, not by the defendants themselves.

The Lost Bank is a story of hubris on a massive scale. Although the book is focused on Washington Mutual, the much broader picture of what was happening in the national real estate market inevitably intrudes. Loan officers who acted more like salespeople than sage consultants. Banks that packaged up hundreds of bad loans as investment instruments without disclosing the very real risks of default. Wall Street investors who eagerly bought those instruments without awareness of their inherent unreliability. And borrowers who were often bamboozled by the terminology, but who nonetheless were eager to own a piece of the American dream. It was in one sense the ultimate financial craze that necessarily resulted in its own demise.

I heartily recommend this book to anyone who wants to understand why Washington Mutual collapsed. And because Ms. Grind does such a good job of describing the broader market conditions that prevailed the reader will also have a good understanding of why and how the entire real estate market turned sour in the early 2000s.

Genghis Khan and the Making of the Modern World by Jack Weatherford was published in 2004. It’s the story of the rise and demise of the largest empire in world history– the Mongol Empire. Here’s how the author describes the astonishing accomplishments of the Mongols:

In twenty-five years, the Mongol army subjugated more land and people than the Romans had conquered in four hundred years. Genghis Khan, together with his sons and grandsons, conquered the most densely populated civilizations of the thirteenth century. Whether measured by the total number of people defeated, the sum of the countries annexed, or by the total area occupied, Genghis Khan conquered more than twice as much as any other man in history.
Genghis Khan and the Making of the Modern World, Weatherford, pg. xviii

I had known something about the Mongol Empire before I read the book, but it really helped me understand what the Empire really was and how it worked. During the Cold War the Soviets suppressed all research into Genghis Khan. The region of his homeland in Mongolia was strictly off limits and much of the surrounding area was used for artillery practice. Scholars who probed the history of the Mongols were censored, and publication of works about Genghis Khan were forbidden.

The collapse of the Soviet Union meant that scholars could begin to research the history of the Empire, but there was another problem– the Mongols were very secretive about the inner workings of their society. A set of documents known as The Secret History of the Mongols supposedly narrated the history of the Empire from the perspective of an insider– an actual eyewitness to the events that subjected more than 3 billion people to Mongol rule. But the Secret History had long since been lost.

In the early 20th century a copy of the Secret History was found in Beijing, written in Chinese characters. But the document made to sense to readers of the time because it preserved Mongolian sounds in a code written in Chinese characters. It wasn’t until the 1970s that Mongolian and English translations first appeared in print– the product of decades of slow but steady scholarship. But even then the Secret History was mostly incomprehensible to modern readers because it assumed a deep understanding of common cultural practices and beliefs of Mongolian society, and of the geography of Mongolia.

By the time of the collapse of the Soviet Union scholars from around the world had pieced together a fair picture of how the Secret History should be read. Weatherford had absorbed much of this research and in 1998 he traveled to Mongolia to get some background information on the region and the people. He expected that it would take him a short time to put together the finishing touches on the book he had been writing– but he ultimately spent another five years there. He learned how to ride horses as the Mongolians rode them. He learned how to shoot a bow and arrow the way that Mongolian soldiers did. And he learned about the many Mongolian traditions on which their society was based. His book represents the culmination of a century of scholarly research and his own five years of in depth immersion in Mongolian society.

The Mongols were tremendous warriors. They developed a large repertoire of innovative tactics, many of which changed warfare forever. For example, in ancient times it was traditional to conduct war in the spring, summer, and fall. Winter was a time to consolidate one’s forces, to rebuild supply lines, and to tend to the wounded. But the Mongols often launched their attacks in winter, rather than the spring– thereby turning the traditions of warfare inside-out. As people of the steppe, the Mongols were perfectly adapted to conducting war in ice and snow. Their conquest of northern China gave them access to gunpowder– used by the Chinese for fireworks. The Mongols changed the formula for making gunpowder to make it burn instantly rather than to glow slowly as it had been used by the Chinese– and they quickly adapted it for use in weapons. As a result the Mongols forever changing the mechanics of the siege. And they were absolute masters of using deception to mask their real objectives and intent in battle. It was a type of tactic that had long been employed by their ancestors on the steppe, and one that they adapted for use on the grand stage of Asia to devastating effect.

The Mongols built only one major city– Karakorum, the Mongol capitol in the heart of Mongolia. They created no monuments, no sculptures, no art. From ancient times the residents of the steppe had lived as nomads– and Mongolian soldiers were as much at home in a saddle as in a tent. They simply didn’t see a need to stay rooted at a single location. The Empire was driven by Mongolian societal traditions that expected a tribal leader to distribute wealth to the other members of his tribe. And that tradition demanded that the Mongols had always to obtain new riches, necessarily acquired through new conquests. Their relentless drive took them from the far reaches of east Asia to the Mediterranean Sea. It wasn’t until the Mongol army was defeated by the Mamluks at the small town of Ayn al-Jalut that the Empire’s expansion was brought to an end.

When the Mongols arrived at a city that they intended to conquer they announced to the city leaders that they could either surrender– or die. It was no idle threat. The Mongols had perfected the art of the siege, and inevitably a city under siege would fall. Once the Mongols had control they assassinated the wealthy oligarchs, appropriated their riches, and demanded absolute loyalty from those who were appointed to rule. The city would then be plundered and riches taken from it would be returned to Mongolia to be redistributed to Mongol society generally.

But the Mongols weren’t just rapacious plunderers. They instituted many innovations across the broad expanse of their Empire, including a postal system and tax incentives that were friendly to business enterprises. They allowed all religions to flourish, so long as religious leaders did not challenge the Mongol right to rule. As the book’s title suggests, the Mongols were to a large extent responsible for ripping the medieval world out of its parochial slumber into a new age of cosmopolitan awareness, international trade, and religious toleration.

This book is very well written, thoroughly researched, and a delight to read. It fills in many gaps I had in my understanding of the Mongols’ place in history. I therefore heartily recommend it to anyone who wishes to know more about one of the most transformational periods of history.

Category: History

Book review: The Lost Bank

Book Review: Genghis Khan