Suit reveals new details on WaMu's weakened controls

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As Washington Mutual ramped up its “high-risk” mortgage efforts in the middle of the last decade, the lender faced a key bottleneck: its own risk-management and quality-control operations.

Those divisions, whose job was to make sure WaMu didn’t take on too much risk and accurately described the loan packages it sold to investors, were perceived as expensive drags on a key profit center.

Now, internal WaMu documents recently made public as part of a federal lawsuit give new details about the numerous ways in which WaMu executives systematically weakened those controls.

They included slashing the internal quality-control staff; allowing loan officers to give mortgages to people with ever-lower credit scores without verifying their income or assets; and directing outside due-diligence consultants to give passing grades to subprime loans that the consultants had initially deemed defective.

If such loans, which generally were made to borrowers with poor or limited credit histories, could not be bundled into securities and sold to investors, WaMu itself would have had to retain them, and the risk they represented.

“I think it is important that we reduce the number of due-diligence rejects as much as possible since the current percentage is excessive,” wrote Michael Coyne, first vice president of WaMu’s capital markets group, to due-diligence consultant Clayton Holdings in an early 2006 email.

The trove of internal reports, memos, emails and depositions from former WaMu officials was filed earlier this month as part of a lawsuit by Franco-Belgian financial-services firm Dexia against JPMorgan Chase.

Chase acquired WaMu in September 2008 after regulators seized the giant thrift; six months earlier Chase had bought Bear Stearns, another big player in the mortgage bubble named in the suit.

Between February 2006 and August 2007 — arguably the height of the mortgage mania — a Dexia unit bought $1.6 billion worth of mortgage-backed securities issued by the three firms, including $385 million issued by WaMu and its subprime-lending subsidiary, Long Beach Mortgage.

Those securities plummeted in value after the bubble’s collapse: An expert hired by Dexia pegged the unit’s total losses on the WaMu deals at $203.1 million.

Dexia now claims that WaMu and the other defendants misrepresented the quality and characteristics of mortgages underpinning the securities, and the rigor with which they were examined before they were sold off.

WaMu’s progressive weakening of its lending standards and internal controls has been described before, notably in testimony three years ago by former WaMu executives before a Senate investigative subcommittee.

But the newly released documents offer further glimpses into how the push for growth played out inside the thrift.

WaMu hoped to grow its “higher margin” mortgage business — subprime loans, pay-option adjustable-rate mortgages, home-equity loans and so-called “Alt-A” loans — from 49 percent of home loans in 2005 to 82 percent by 2008, according to an email dated April 18, 2006.

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