(Source: The Seattle Times By Sanjay Bhatt) - Firing the biggest shot yet in a promised barrage of litigation against executives of failed banks, federal regulators Thursday sued the three men who led Washington Mutual as its home-loan losses ballooned during the financial crisis.The Federal Deposit Insurance Corp. alleged Seattle-based WaMu lost billions of dollars due to negligent actions by Kerry Killinger, WaMu’s former CEO; Stephen Rotella, former chief operating officer; and David Schneider, former president of WaMu’s Home Loans division. The suit also names Killinger’s wife, Linda, and Rotella’s wife, Esther, claiming they participated in transferring assets into trusts where they would be out of creditors’ reach.
The FDIC sought more than $900 million from the executives in private negotiations preceding the lawsuit, a source familiar with the matter said. It has a $125 million settlement with WaMu’s outside directors pending approval in bankruptcy court.
The suit, filed in federal court in Seattle, doesn’t specify how much in damages the FDIC seeks to collect.
Killinger presided as chief executive of WaMu from 1990 to early September 2008, when the board of directors fired him. Federal regulators closed the bank on Sept. 25 and sold it to JPMorgan Chase for $1.9 billion. The next day, WaMu’s holding company filed for bankruptcy.
WaMu remains the largest bank to fail in U.S. history.
The FDIC suit says it intends “to hold these three highly paid senior executives, who were chiefly responsible for WaMu’s higher risk home lending program, accountable for the resulting losses.”
The FDIC also asked the court to freeze certain assets, including bank accounts and homes of the executives, pending a trial.
In a statement, Killinger called the FDIC’s allegations “fiction,” and the legal conclusions “political theater.”
“The management of Washington Mutual was sound and prudent,” Killinger said. “Not one dime was lost by the FDIC insurance fund on the seizure and sale of the bank.”
In an open letter, Rotella denounced “this abuse of power by the FDIC,” calling it “patently unfair for the FDIC to expect an individual to have perfect foresight into a crisis that the FDIC itself did not see coming.”
Calls to Schneider’s home in Princeton, N.J., were not returned.
Aggressive growth
The lawsuit portrays Killinger as the architect of an aggressive growth strategy that involved generating high volumes of risky home loans, juicing short-term profits to boost his pay but exposing the bank to potentially catastrophic losses.
Rotella and Schneider arrived at WaMu in 2005 and became the chief facilitators of Killinger’s flawed strategy, which amounted to “gambling billions of dollars of WaMu’s money,” the lawsuit alleges.
The defendants “led WaMu on this lending spree knowing that the real-estate market was in a ‘bubble’ that could not support such a risky strategy over the long term, that WaMu did not have the technology to adequately manage and evaluate the higher risks associated with the portfolio,” the FDIC alleges in 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,” the FDIC alleges.
The FDIC’s lawsuit zeros in on how the executives’ risky strategy turned the bank’s “held-for-investment” home-loan portfolio — those loans kept on the bank’s books — into a ticking time bomb.
When WaMu failed, this portfolio totaled $177 billion, according to the suit. Option ARMs — loans on which homeowners could end up owing much more than they borrowed, raising the risk of default — and home-equity loans together accounted for more than half of the portfolio.
The three executives repeatedly assured WaMu’s board that they were properly pricing loans for the risks, but that wasn’t true, the FDIC alleged.
WaMu’s top credit officer warned Killinger that the bank was “putting borrowers into homes that they simply cannot afford,” according to the complaint. He’s unnamed in the complaint.
Rotella stripped the bank’s central risk-management group of its independence and authority, the suit alleges. Both Killinger and Rotella were heard to deride risk managers as “checkers checking checkers,” according to the suit.
And in August 2005, Schneider — whose mandate to managers was “be bold” — recruited a chief risk officer for the home-loans division who had scant experience in risk management and none at a bank, according to the complaint.
In 2006, WaMu’s companywide risk officer warned the three executives of the danger posed by the bank’s narrow focus on markets like California and Florida and on risky variable-rate home loans.
“A severe ‘twin shock’ of sustained housing price decline and rising interest rates could cause a 3x increase in mortgage charge-offs,” the risk officer wrote in a report.
The three WaMu executives treated the top risk officer “dismissively,” left him out of important meetings and fired him in May 2008, the FDIC alleges.
Instead of changing course, WaMu pushed harder, the suit alleges.
As of early February 2008, WaMu’s exposure to home loans was higher than that of any bank in the nation, when compared with its capital base, the FDIC says in the suit.
The bank’s losses mounted as the housing market deteriorated. For example, subprime loans written off as uncollectable exploded from $47 million in 2005 to $956 million in the first six months of 2008.
Executive compensation
WaMu’s strategy brought short-term rewards for the top executives. From January 2005 to September 2008, they collectively received more than $95 million in compensation, according to the lawsuit.
In August 2008, as WaMu’s finances spiraled downward, Killinger and his wife transferred their homes in The Highlands just north of Seattle, and Palm Desert, Calif., into irrevocable trusts. The lawsuit says the purpose was to “hinder, delay or defraud” existing creditors and those who Killinger feared might come after him.
Rotella and his wife did the same that spring with their home in Orient, N.Y., the FDIC alleges, and Rotella transferred more than $1 million to his wife after WaMu failed.
While the FDIC did not have to tap its deposit insurance fund in WaMu’s failure, the banking company’s creditors did lose money. What they will collect is still being hashed out in bankruptcy court in Delaware.
Any money the FDIC recoups from its lawsuit against the WaMu executives would be used to repay those creditors. It’s highly unlikely anything will be left for WaMu stockholders, who were wiped out when the bank was seized.
WaMu isn’t the only bank whose executives face litigation. The FDIC said it has authorized lawsuits against 158 defendants with potential damages of $3.57 billion related to the recent financial crisis.
But only handful of lawsuits have yet been filed — the WaMu suit is just the sixth, said Paul Hinton, of NERA Economic Consulting in New York. The FDIC typically only sues after sending demand letters to the officers’ professional liability insurers, he said.
Hinton said the agency’s task in making its case against a big bank’s management will be tough.
“It may be harder to show a direct connection between the particular conduct that led to losses at the bank and particular failures of professional conduct at very senior levels of management,” he said.
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