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09/19/2012

Book Review: The Lost Bank


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At the time of its collapse in 2008, Washington Mutual had assets of $307 billion. It was the largest failure in American history. The details of the epic failure have been covered, but never in the humanizing manner we see in The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American History. Author Kirsten Grind tells the story in detailed and graphic form, providing what others have described as a “fly-on-the-boardroom account” of what happened, which reads like a novel. The uniquely written narrative will appeal to everyone—despite their professional background. Grind provides the number crunching details for finance professionals, in addition to the touching perspectives of the customers. In retrospect, the story sounds fantastic and bizarre as this more than 100-year-old bank rode the subprime mortgage boom over the edge to disaster. But as the bank hurtled to catastrophe, it seemed a hugely profitable and often admired financial institution.

The story begins with Lou Pepper becoming CEO in 1981, after the bank was on the verge of failure. A lawyer by trade and a then-trustee (trustees were later termed board members after Washington Mutual went public) of Washington Mutual, Pepper was admittedly underqualified to hold the position. As he noted after he accepted the role, “I have never managed anything and now I’m the CEO.” His unorthodox management style aside, by 1986 Pepper had (temporarily) saved Washington Mutual. Of course, the story started to turn after Kerry Killinger became president in 1988. He embarked on a vast acquisition and aggressive expansion program, which included buying H. F. Ahmanson Company for $10 billion. By 1998, assets were $150 billion. Killinger is quoted as saying, "In the past three years, we have done what no other bank in history has done."

The book describes him as the "Energizer Banker." In its expansion, the bank advertised they "could make a mortgage easier" with "The Power of Yes,” but others readily saw the flaw in this approach. An account executive at their Long Branch Mortgage subsidiary said, "I wouldn't lend some of these people money to buy a bicycle never mind a house." A later credit audit of 4,000 mortgages showed only 950 were good enough to have sold, but, the low quality of the mortgage loans didn't affect the mortgage pool sales business whose profits quickly reached $1.4 billion a year.

Washington Mutual eventually became the largest servicer of mortgages and the second largest originator. But, management skills didn't keep up with this dynamic growth. The bank is described as a "company that operated like Disneyland—lots of splashy, grand ideas and dress-up time on Hollywood but little substance." Wall Street didn’t help. "Analysts had been pressuring the bank to start taking on more risk on credit. There was no better way to do this other than making riskier loans."

At one point, the chief risk manager warned, "My credit team and I fear that we are considering expanding our risk appetite at exactly the wrong point." This warning was ignored. Oddly, Killinger saw the risks, but kept adding low quality loans. "All the classic signs are there and the outcome is probably not great. We would all like to think the air can come out of the balloon slowly, but history would not lean you in that direction," he commented. Killinger is hard to understand, as he kept rushing over the edge. Perhaps he thought he could control the situation. If so, this was delusion at the CEO level.

Of course, one wonders why the board didn't grasp what was going on and take action. The Lost Bank is a case study of poor risk management. There was a rapid turnover of risk managers. As the book details, "No one was providing a singular clear vision of how to fix all the loan issues." Despite this lack of timely risk input, the board could have easily seen the dangers in subprime mortgages by reading the local newspapers.

Wall Street Journal reporter Kirsten Grind chronicled the Washington Mutual story from the beginning during her days at the Puget Sound Business Journal in Seattle. In the two years preparing the book, her research included over 200 interviews and more than 10,000 documents. The end result is a classic book on financial speculation and incompetent bank management.

Readers of The Lost Bank will think, “we will never make these foolish mistakes again." Unfortunately, financial history tells us we will.

–Bill Hayes

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