Wall Street and the Financial Crisis: Anatomy of a Financial Collapse
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
¶United States Senate
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
¶Committee on Homeland Security and Governmental Affairs
Carl Levin, Chairman Tom Coburn, Ranking Minority Member
WALL STREET AND
¶THE FINANCIAL CRISIS: Anatomy of a Financial Collapse
MAJORITY AND MINORITY STAFF REPORT PERMANENT SUBCOMMITTEE ON INVESTIGATIONS UNITED STATES SENATE
¶April 13,2011 For more information about this December 14 meeting, see discussion in Section C(4)(b), above.
SENATOR CARL LEVIN
¶Chairman
SENATOR TOM COBURN, M.D. Ranking Minority Member
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS ELISE J. BEAN
¶Staff Director and Chief Counsel
ROBERT L. ROACH
¶Counsel and Chief Investigator
LAURA E. STUBER
¶Counsel
ZACHARY I. SCHRAM
¶Counsel
DANIEL J. GOSHORN
¶Counsel
DAVID H. KATZ
¶Counsel
ALLISON F. MURPHY
¶Counsel
ADAM C. HENDERSON
¶Professional Staff Member
PAULINE E. CALANDE MICHAEL J. MARTINEAU
¶Detailee Detailee
CHRISTOPHER J. BARKLEY
¶Staff Director to the Minority
ANTHONY G. COTTO
¶Counsel to the Minority
KEITH B. ASHDOWN
¶Chief Investigator to the Minority
JUSTIN J. ROOD
¶Senior Investigator to the Minority
VANESSA CAREIRO HELENA MAN
¶Law Clerk Law Clerk
BRITTANY CLEMENT JOSHUA NIMMO
Law Clerk Intern DAVID DeBARROS ROBERT PECKERMAN Law Clerk Intern
ERIN HELLING TANVI ZAVERI
¶Law Clerk Law Clerk
MARY D. ROBERTSON
¶Chief Clerk
¶5/10/11
Permanent Subcommittee on Investigations 199 Russell Senate Office Building – W ashington, D.C. 20510 Main Number: 202/224-9505 W eb Address: www.hsgac.senate.gov [Follow Link to "Subcommittees," to "Investigations"]
WALL STREET AND THE FINANCIAL CRISIS: Anatomy of a Financial Collapse
TABLE OF CONTENTS
¶I. EXECUTIVE SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 S&P issues ratings using the "AAA" designation; Moody's equivalent rating is "Aaa." For ease of reference, this Report will refer to both ratings as "AAA." and Point Pleasant, Goldman received a direct fee for acting as the collateral put provider. Goldman representatives told the Subcommittee that, because the put fee was "embedded" in the CDS agreement in some of the CDOs, Goldman's operations group sometimes overlooked and failed to "book" the profit and loss associated with those put arrangements. W hen this oversight was discovered in 2007, Goldman identified 18 CDO put arrangements that had not been identified and accounted for in Goldman's books. See 6/28/2007 email from Carly Scales to Phil Armstrong and Steve Schultz, GS MBS-E-015192547: • "Current Put Option Booking State: 22 Deals with the Put Option Feature C 4 Deals that do have a Put Option Booked: - For these trades, Ops [the operations group] knew about the Put as there was a confirmation and a trade booked. ... • 18 Deals that do not have a Put option Booked: - For these deals, there was no mention of a Put at all at the time of closing. ... - The Put option was embedded into the deal documents (Indenture, Offering Circular, etc – both of which are reviewed by outside counsel and GS legal as a normal course of business – but are not reviewed by Operations.) - For these trades, an intermediation fee was being taken on the CDS trades, but no specific Put was booked in our systems. - The original explanation from the desk was the intermediation fee was being taken for the risks associated with standing in between the Street and the deal with no mention of the Put."
A. Subcommittee Investigation . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 S&P issues ratings using the "AAA" designation; Moody's equivalent rating is "Aaa." For ease of reference, this Report will refer to both ratings as "AAA." and Point Pleasant, Goldman received a direct fee for acting as the collateral put provider. Goldman representatives told the Subcommittee that, because the put fee was "embedded" in the CDS agreement in some of the CDOs, Goldman's operations group sometimes overlooked and failed to "book" the profit and loss associated with those put arrangements. W hen this oversight was discovered in 2007, Goldman identified 18 CDO put arrangements that had not been identified and accounted for in Goldman's books. See 6/28/2007 email from Carly Scales to Phil Armstrong and Steve Schultz, GS MBS-E-015192547: • "Current Put Option Booking State: 22 Deals with the Put Option Feature C 4 Deals that do have a Put Option Booked: - For these trades, Ops [the operations group] knew about the Put as there was a confirmation and a trade booked. ... • 18 Deals that do not have a Put option Booked: - For these deals, there was no mention of a Put at all at the time of closing. ... - The Put option was embedded into the deal documents (Indenture, Offering Circular, etc – both of which are reviewed by outside counsel and GS legal as a normal course of business – but are not reviewed by Operations.) - For these trades, an intermediation fee was being taken on the CDS trades, but no specific Put was booked in our systems. - The original explanation from the desk was the intermediation fee was being taken for the risks associated with standing in between the Street and the deal with no mention of the Put." B. Overview . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 See McFadden Act of 1927, P.L. 69-639 (prohibiting national banks from owning branches in multiple states); Bank Holding Company Act of 1956, P.L. 84-511 (prohibiting banking company companies from owning branches in multiple states). See also "Going Interstate: A New Dawn for U.S. Banking," The Regional Economist, a publication of the Federal Reserve Bank of St. Louis (7/1994). b; 1/2005 "Higher Risk Lending Strategy 'Asset Allocation Initiative,'" submitted to Washington Mutual Board of Directors Finance Committee Discussion, JPM_WM00302975-93, Hearing Exhibit 4/13-2a. to Paulson"); 12/7/2006 email chain between Daniel Sparks and Tom Montag, "More thorough response," GS MBS-E-010931324 (Goldman had previously handled approximately $9 billion in transactions for Paulson); Subcommittee interview of Michael Swenson (4/16/2010) ("Paulson [hedge fund] was the biggest counterparty on day 1 [of the ABX Index] and throughout 2006"). (1) High Risk Lending: Case Study of Washington Mutual Bank. . . . . . . . . . . . . . . . . .2 See McFadden Act of 1927, P.L. 69-639 (prohibiting national banks from owning branches in multiple states); Bank Holding Company Act of 1956, P.L. 84-511 (prohibiting banking company companies from owning branches in multiple states). See also "Going Interstate: A New Dawn for U.S. Banking," The Regional Economist, a publication of the Federal Reserve Bank of St. Louis (7/1994). b; 1/2005 "Higher Risk Lending Strategy 'Asset Allocation Initiative,'" submitted to Washington Mutual Board of Directors Finance Committee Discussion, JPM_WM00302975-93, Hearing Exhibit 4/13-2a. to Paulson"); 12/7/2006 email chain between Daniel Sparks and Tom Montag, "More thorough response," GS MBS-E-010931324 (Goldman had previously handled approximately $9 billion in transactions for Paulson); Subcommittee interview of Michael Swenson (4/16/2010) ("Paulson [hedge fund] was the biggest counterparty on day 1 [of the ABX Index] and throughout 2006"). (2) Regulatory Failure: Case Study of the Office of Thrift Supervision. . . . . . . . . . . . . .4 1/3/2011 chart, "Insurance Fund Ten-Year Trends," supplied by the National Credit Union Administration (showing that, as of 12/31/1993, the United States had 12,317 federal and state credit unions). N%20FGCAnnouncesDefaultNoticewithRRELoanTransactions.pdf. See also "CapitalSource to Acquire Fremont's Retail Arm," New York Times (4/14/2008). Q07 Fact Sheet prepared for David Viniar, GS MBS-E-009724276, Hearing Exhibit 4/27-159. (3) Inflated Credit Ratings: Case Study of Moody's and Standard & Poor's. . . . . . . . . .5 Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, P.L. 103-328 (repealing statutory prohibitions on interstate banking). Feb07.xls," GS MBS-E-012744553; chart attachments to 2/23/2007 email from Tom Barrett to Kevin Kao, Michael Swenson and Justin Gmelich, "Index and Single Name Position History 2006 As of 22Feb07.xls," GS MBS-E-012411673; chart attachments to 3/2/2007 email from Kevin Kao to Joshua Birnbaum, "Index and Single Name Position History 2006 As of 01Mar07.xls," GS MBS-E-012776557. (4) Investment Bank Abuses: Case Study of Goldman Sachs and Deutsche Bank.. . . . .7 Gramm-Leach-Bliley Act of 1999, also known as the Financial Services Modernization Act, P.L. 106-102. Some banks had already begun to engage in securities and insurance activities, with the most prominent example at the time being Citicorp's 1998 merger with the Travelers insurance group. C. Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 See "Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities," RIN 3235-AI96, 17 CFR Parts 200 and 240 (8/20/2004) ("amended the net capital rule under the Securities Exchange Act of 1934 to establish a voluntary alternative method of computing net capital for certain broker-dealers"). The Consolidated Supervised Entities (CSE) program, which provided SEC oversight of investment bank holding companies that joined the CSE program on a voluntarily basis, was established by the SEC in 2004, and terminated by the SEC in 2008, after the financial crisis. The alternative net capital rules for broker- dealers were terminated at the same time. CFR § 360.6. CFR § 360.6(b)(5)(i). U.S.C. § 1820(b)(3).
¶II. BACKGROUND. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 "Not What They Had In Mind: A History of Policies that Produced the Financial Crisis of 2008," September 2009, Mercatus Center, http://mercatus.org/sites/default/files/publication/NotWhatTheyHadInMind(1).pdf.
¶A. Rise of Too-Big-To-Fail U.S. Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . .15 "Not What They Had In Mind: A History of Policies that Produced the Financial Crisis of 2008," September 2009, Mercatus Center, http://mercatus.org/sites/default/files/publication/NotWhatTheyHadInMind(1).pdf.
¶B. High Risk Mortgage Lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 Interagency "Expanded Guidance for Subprime Lending Programs, (1/31/2001) at 3. See also "Understanding the Securitization of Subprime Mortgage Credit," by Adam Ashcraft and Til Schuermann, Federal Reserve Bank of New York Staff Report No. 318, (3/2008) at 14.
¶C. Credit Ratings and Structured Finance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 For more information about Long Beach, see Chapter III of this Report. For more information about New Century and Fremont, see section (D)(2)(c)-(d) of Chapter IV.
¶D. Investment Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 See id. at 14.
¶E. Market Oversight. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 See "Estimation of Housing Bubble: Comparison of Recent Appreciation vs. Historical Trends," chart prepared by Paulson & Co. Inc., Hearing Exhibit 4/13-1j.
¶F. Government Sponsored Enterprises. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41 For more detail on these matters, see Chapter V, below.
¶G. Administrative and Legislative Actions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43 3/14/2008 compliance letter from S&P to SEC, SEC_OCIE_CRA_011218-59, at 20. These numbers represent the RMBS or CDO pools that were presented to S&P which then issued ratings for multiple tranches per RMBS or CDO pool. (See Chapter V below.)
¶H. Financial Crisis Timeline. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45 "U.S. Structured Ratings Fee Schedule Residential Mortgage-backed Financings and Residential Servicer Evaluations," prepared by S&P, S&P-PSI 0000028-35; and "U.S. Structured Ratings Fee Schedule Collateralized Debt Obligations Amended 3/7/2007," prepared by S&P, S&P-PSI 0000036-50. (See Chapter V below.)
¶III. HIGH RISK LENDING:
¶CASE STUDY OF WASHINGTON MUTUAL BANK. . . . . . . . . . . . . . . . . . . . . . . . . . .48 3/14/2008 compliance letter from S&P to SEC, SEC_OCIE_CRA_011218-59, at 18-19. (See Chapter V below.)
¶A. Subcommittee Investigation and Findings of Fact.. . . . . . . . . . . . . . . . . . . . . . . . . . . .50 9/10/2007 Transcript of Raymond McDaniel at Moody's MD Town Hall Meeting, Hearing Exhibit 4/23-98.
¶B. Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 1/2003 "Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets," prepared by the SEC, at 40. The report continued: "[C]oncerns had been expressed that a rating agency might be tempted to give a more favorable rating to a large issue because of the large fee, and to encourage the issuer to submit future large issues to the rating agency." Id. at 40 n.109.
¶(1) Major Business Lines and Key Personnel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 1/2003 "Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets," prepared by the SEC, at 40. The report continued: "[C]oncerns had been expressed that a rating agency might be tempted to give a more favorable rating to a large issue because of the large fee, and to encourage the issuer to submit future large issues to the rating agency." Id. at 40 n.109.
¶(2) Loan Origination Channels. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 See, e.g., 3/26/2010 "Fitch Ratings Global Structured Finance 2009 Transition and Default Study," prepared by Fitch.
¶(3) Long Beach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 See, e.g., "Percent of the Original AAA Universe Currently Rated Below Investment Grade," chart prepared by BlackRock Solutions, Hearing Exhibit 4/23-1i. See also 3/2008 "Understanding the Securitization of Subprime Mortgage Credit," Federal Reserve Bank of New York Staff Report no. 318, at 58 and chart 31 ("92 percent of 1st-
¶(4) Securitization.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55 2/2008 "Structured Finance Ratings Transitions, 1983-2007," Credit Policy Special Comment prepared by Moody's, at 4.
¶(5) Overview of WaMu's Rise and Fall. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56 6/24/2010 supplemental response from S&P to the Subcommittee, Exhibit N, Hearing Exhibit 4/23-108 (1/30/2008 "S&P Takes Action on 6,389 U.S. Subprime RMBS Ratings and 1,953 CDO Ratings," S&P's RatingsDirect). Ratings may appear on CreditWatch when events or deviations from an expected trend occur and additional information is needed to evaluate the rating.
¶C. High Risk Lending Strategy.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 See, e.g., Securities Act of 1933 §§ 3(b) and 4(2); 17 CFR § 230.501 et seq. (Regulation D).
¶(1) Strategic Direction.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 For a detailed discussion of market making, see "Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds," prepared by the Financial Stability Oversight Council, at 28-29 (Jan. 18, 2011) (citing SEC Exchange Act Rel. No. 34-58775 (Oct. 14, 2008)).
¶(2) Approval of Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 For a detailed discussion of market making, see "Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds," prepared by the Financial Stability Oversight Council, at 28-29 (Jan. 18, 2011) (citing SEC Exchange Act Rel. No. 34-58775 (Oct. 14, 2008)).
¶(3) Definition of High Risk Lending.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62 Securities Exchange Act of 1934, Rule 15c3-1.
¶(4) Gain on Sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64 For more information, see Chapter VI, section discussing Deutsche Bank.
¶(5) Acknowledging Unsustainable Housing Price Increases.. . . . . . . . . . . . . . . . . . . . . . 65
¶(6) Execution of the High Risk Lending Strategy.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
¶D. Shoddy Lending Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 The Dodd-Frank Act has since abolished one of these agencies, the Office of Thrift Supervision, and assigned its duties to the OCC. See Chapter IV. Fed. Reg. 185 (9/24/2010). ("[f]or residential loans, we have not bought much lately"); 3/26/2007 Goldman presentation to Board of Directors, "Subprime Mortgage Business," GS MBS-E-005565527, Hearing Exhibit 4/27-22 (reporting that Mortgage Department is using "conservative bids" on loans); 3/14/2007 Goldman Presentation to SEC, "Subprime Mortgage Business 14-Mar-2007," at 7, GS MBS-E-010022328; 3/2/2007 email to Craig Broderick, "Audit Committee Package_Feb 21_Draft_Mortgage_Page.ppt," GS M BS-E-009986805, Hearing Exhibit 4/27-63 (we are "lowballing" bids on loans).
¶(1) Long Beach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 The Dodd-Frank Act has since abolished one of these agencies, the Office of Thrift Supervision, and assigned its duties to the OCC. See Chapter IV. Fed. Reg. 185 (9/24/2010). ("[f]or residential loans, we have not bought much lately"); 3/26/2007 Goldman presentation to Board of Directors, "Subprime Mortgage Business," GS MBS-E-005565527, Hearing Exhibit 4/27-22 (reporting that Mortgage Department is using "conservative bids" on loans); 3/14/2007 Goldman Presentation to SEC, "Subprime Mortgage Business 14-Mar-2007," at 7, GS MBS-E-010022328; 3/2/2007 email to Craig Broderick, "Audit Committee Package_Feb 21_Draft_Mortgage_Page.ppt," GS M BS-E-009986805, Hearing Exhibit 4/27-63 (we are "lowballing" bids on loans). i
(2) WaMu Retail Lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86 9/26/2008 SEC press release, "Chairman Cox Announces End of Consolidated Supervised Entities Program," http://www.sec.gov/news/press/2008/2008-230.htm. (a) Inadequate Systems and Weak Oversight. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86 9/26/2008 SEC press release, "Chairman Cox Announces End of Consolidated Supervised Entities Program," http://www.sec.gov/news/press/2008/2008-230.htm. (b) Risk Layering. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90 Congress authorized the Federal Reserve to issue the regulations in Section 151 of the Home Ownership and Equity Protection Act of 1994 (HOEPA), P.L. 103-325. The Federal Reserve did not issue any regulations under HOEPA, however, until July 2008, when it amended Regulation Z. The new rules primarily strengthened consumer protections for "higher priced loans," which included many types of subprime loans. See "New Regulation Z Rules Enhance Protections for Mortgage Borrowers," Consumer Compliance Outlook (Fourth Quarter 2008) (Among (c) Loan Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 Id. (d) Steering Borrowers to High Risk Option ARMs. . . . . . . . . . . . . . . . . . . . . . . . .104 Many of these events are based upon a timeline prepared by the Federal Reserve Bank of St. Louis, "The Financial Crisis: A Timeline of Events and Policy Actions," http://timeline.stlouisfed.org/index.cfm?p=timeline. (e) Marginalization of WaMu Risk Managers.. . . . . . . . . . . . . . . . . . . . . . . . . . . . .109 4/2010 "Evaluation of Federal Regulatory Oversight of Washington Mutual Bank," report prepared by the Offices of Inspector General at the Department of the Treasury and Federal Deposit Insurance Corporation, Hearing Exhibit 4/16-82 (hereinafter "IG Report"). E. Polluting the Financial System. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 "Securitizations of Washington Mutual Subprime Home Loans," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c. (1) WaMu and Long Beach Securitizations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 "Securitizations of Washington Mutual Subprime Home Loans," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c. (2) Deficient Securitization Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122 See, e.g., wamusecurities.com (subscription website maintained by JPMorgan Chase with data on Long Beach and WaMu mortgage backed securities showing, as of March 2011, delinquency rates for particular mortgage backed securities, including LBMLT 2006-1 – 58.44%; LBMLT 2006-6 – 60.06%; and LBMLT 2005-11 – 54.32%). (3) Securitizing Delinquency-Prone Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125 Subcommittee interview of David Beck (3/2/2010). (4) WaMu Loan Sales to Fannie Mae and Freddie Mac. . . . . . . . . . . . . . . . . . . . . . . . . .136 Id. F. Destructive Compensation Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143 See 8/2006 Washington Mutual internal report, "Option ARM Credit Risk," chart entitled, "Borrower-Selected Payment Behavior," at 7, Hearing Exhibit 4/13-37. The WaMu report also stated: "Almost all Option ARM borrowers select the minimum payment every month with very high persistency, regardless of changes in the interest rates or payment adjustments." Id. at 2. (1) Sales Culture. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143 See 8/2006 Washington Mutual internal report, "Option ARM Credit Risk," chart entitled, "Borrower-Selected Payment Behavior," at 7, Hearing Exhibit 4/13-37. The WaMu report also stated: "Almost all Option ARM borrowers select the minimum payment every month with very high persistency, regardless of changes in the interest rates or payment adjustments." Id. at 2. (2) Paying for Speed and Volume. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .147 Id. at 11. (a) Long Beach Account Executives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .148 6/1/2004 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, "Strategic Direction," JPM_WM05385579 at 581. (b) WaMu Loan Consultants. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .149 Id. at 582. (c) Loan Processors and Quality Assurance Controllers. . . . . . . . . . . . . . . . . . . . . .151 Id. at 585. (3) WaMu Executive Compensation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153 See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001509, Hearing Exhibit 4/16-94 [Sealed Exhibit]. G. Preventing High Risk Lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302978, Hearing Exhibit 4/13-2a; see also 4/2010 "WaMu Product Originations and Purchases by Percentage – 2003-2007," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1i. (1) New Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302978, Hearing Exhibit 4/13-2a; see also 4/2010 "WaMu Product Originations and Purchases by Percentage – 2003-2007," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1i. (2) Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a. 1. Ensure "Qualified Mortgages" Are Low Risk. . . . . . . . . . . . . . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a. 2. Require Meaningful Risk Retention. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a. 3. Safeguard Against High Risk Products. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a. 4. Require Greater Reserves for Negative Amortization Loans.. . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a. 5. Safeguard Bank Investment Portfolios.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302979, Hearing Exhibit 4/13-2a.
¶IV. REGULATORY FAILURE:
¶CASE STUDY OF THE OFFICE OF THRIFT SUPERVISION. . . . . . . . . . . . . . . . . . .161 Id. at JPM_WM00302979.
¶A. Subcommittee Investigation and Findings of Fact.. . . . . . . . . . . . . . . . . . . . . . . . . . . .162 12/21/2004 "Asset Allocation Initiative: Higher Risk Lending Strategy and Increased Credit Risk Management," Washington Mutual Board of Directors Presentation, at JPM_WM04107995-8008, Hearing Exhibit 4/13-2b.
¶B. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165 Id. This slide lists only the two additional risk factors quoted, despite referring to "at least three of the following."
(1) Office of Thrift Supervision. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165 Id. This slide lists only the two additional risk factors quoted, despite referring to "at least three of the following." (2) Federal Deposit Insurance Corporation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 See 9/25/2008 "OTS Fact Sheet on Washington Mutual Bank," Dochow_Darrel-00076154_001 ("Loans held: $118.9 billion in single-family loans held for investment – this includes $52.9 billion in payment option ARMs and $16.05 billion in subprime mortgage loans"). (3) Examination Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 1/18/2005 Washington Mutual Inc. Washington Mutual Bank FA Finance Committee Minutes at JPM_WM06293964; see also 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302977, Hearing Exhibit 4/13-2a b.
¶C. Washington Mutual Examination History. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 Id. at 893 [emphasis in original removed].
(1) Regulatory Challenges Related to Washington Mutual.. . . . . . . . . . . . . . . . . . . . . . .169 Id. at 893 [emphasis in original removed]. (2) Overview of Washington Mutual's Ratings History and Closure. . . . . . . . . . . . . . . .173 April 13, 2010 Subcommittee Hearing at 53. (3) OTS Identification of WaMu Deficiencies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177 April 13, 2010 Subcommittee Hearing at 85. (a) Deficiencies in Lending Standards.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177 April 13, 2010 Subcommittee Hearing at 85. (b) Deficiencies in Risk Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182 Id. (c) Deficiencies in Home Appraisals.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187 6/6/2006 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, "Strategic Direction," JPM_00808312-324 at 314, Hearing Exhibit 4/13-6d. (d) Deficiencies Related to Long Beach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191 Id. [formatted for clarity]. (e) Over 500 Deficiencies in 5 Years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .195 Id. at 83. (4) OTS Turf War Against the FDIC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 See id., e.g., at 83-84.
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D. Regulatory Failures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .208 Subcommittee interview of Faye Chapman, WaMu General Counsel (2/9/2010). See also 12/21/2005 OTS memorandum, "Long Beach Mortgage Corporation (LBMC)," OTSWMS06-007 0001010, Hearing Exhibit 4/16-31. (1) OTS' Failed Oversight of WaMu. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209 1/13/2004 report on "Joint Visitation Dated October 14, 2003," jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b (citing a Long Beach quality assurance report). (a) Deference to Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209 1/13/2004 report on "Joint Visitation Dated October 14, 2003," jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b (citing a Long Beach quality assurance report). (b) Demoralized Examiners.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .215 1/13/2004 report on "Joint Visitation Dated October 14, 2003," jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b. (c) Narrow Regulatory Focus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .224 Id. (d) Inflated CAMELS Ratings.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 Subcommittee interview of David Schneider (2/17/2010). (e) Fee Issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Id. at OTSWMS06-007 0001009 (stating WaMu filed a 12/12/2005 application to acquire Long Beach). (2) Other Regulatory Failures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231 Id. at OTSWMS06-007 0001010. (a) Countrywide.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231 Id. at OTSWMS06-007 0001010. (b) IndyMac. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .233 See, e.g., 6/3/2005 OTS internal memorandum by OTS examiner to OTS Deputy Regional Director, at OTSWMS06-007 0002683, Hearing Exhibit 4/16-28. (c) New Century . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .235 "Washington Mutual Regulators Timeline," chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j. (d) Fremont. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237 9/14/2006 WaMu internal email, Hearing Exhibit 4/13-12. E. Preventing Regulatory Failures.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .239 11/7/2006 WaMu internal email, Hearing Exhibit 4/13-50. (1) New Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .239 11/7/2006 WaMu internal email, Hearing Exhibit 4/13-50. (2) Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 Id. 1. Complete OTS Dismantling.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 Id. 2. Strengthen Enforcement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 Id. 3. Strengthen CAMELS Ratings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 Id. 4. Evaluate Impacts of High Risk Lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 Id.
¶V. INFLATED CREDIT RATINGS:
CASE STUDY OF MOODY'S AND STANDARD & POOR'S. . . . . . . . . . . . . . . . . . . . .243 Id. at 3. A. Subcommittee Investigation and Findings of Fact.. . . . . . . . . . . . . . . . . . . . . . . . . . . .245 12/2006 WaMu internal email, Hearing Exhibit 4/13-13a. B. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .247 1/2/2007 email from Ron Cathcart to Cory Gunderson, Hearing Exhibit 4/13-16. (1) Credit Ratings Generally. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .247 1/2/2007 email from Ron Cathcart to Cory Gunderson, Hearing Exhibit 4/13-16. (2) The Rating Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250 Id. at JPM_WM00673103. (3) Record Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .256 Id. at 2. C. Mass Credit Rating Downgrades.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .259 8/20/2007 "Long Beach Mortgage Loan Origination & Underwriting," WaMu audit report, JPM_WM02548939, Hearing Exhibit 4/13-19. (1) Increasing High Risk Loans and Unaffordable Housing. . . . . . . . . . . . . . . . . . . . . . .259 8/20/2007 "Long Beach Mortgage Loan Origination & Underwriting," WaMu audit report, JPM_WM02548939, Hearing Exhibit 4/13-19. (2) Mass Downgrades. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .263 "Securitizations of Washington Mutual Subprime Home Loans," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c. D. Ratings Deficiencies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267 Id. at 55. (1) Awareness of Increasing Credit Risks.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268 Id. at 90. (2) CRA Conflicts of Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .272 Subcommittee interview of Steve Rotella (2/24/2010). (a) Drive for Market Share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273 See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001482, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See also, e.g., 12/17/2004 email exchange among WaMu executives, "Risks/Costs to Moving GSE Share to FH," JPM_WM05501400, Hearing Exhibit 4/16-88 (noting that Fannie Mae "is well aware of our data integrity issues (miscoding which results in misdeliveries, expensive and time consuming data reconciliations), and has been exceedingly patient."). (b) Investment Bank Pressure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .278 3/14/2005 OTS Report of Examination, OTSWMS05-004 0001794, Hearing Exhibit 4/16-94 [Sealed Exhibit]. (Examination findings were issued to WaMu on August 28, 2005.) (3) Inaccurate Models. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .288 4/2010 IG Report, at 24-25, Hearing Exhibit 4/16-82. (a) Inadequate Data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .288 4/2010 IG Report, at 24-25, Hearing Exhibit 4/16-82. (b) Unclear and Subjective Ratings Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .294 April 13, 2010 Subcommittee Hearing at 16. (4) Failure to Retest After Model Changes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .297 April 13, 2010 Subcommittee Hearing at 41. (5) Inadequate Resources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304 6/14/2006 email from Mark Hillis to Cheryl Feltgen, included in a longer email chain involving Mr. Rotella and Mr. Schneider, among others, JPM_WM01311922. (6) Mortgage Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .310 Id. E. Preventing Inflated Credit Ratings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .313 Id. (1) Past Credit Rating Agency Oversight. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .313 Id.
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(2) New Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .315 See, e.g., OTS document, "Hybrid ARM Lending Survey" (regarding WaMu), undated but the OTS Examiner-in- Charge estimated it was prepared in March or mid-2007, JPM_WM03190673 ("For Subprime currently up to 100% LTV/CLTV with 50% DTI is allowed for full Doc depending on FICO score. Up to 95% LTV/CLTV is allowed with 50% DTI for Stated Doc depending on FICO score. … For No Income Verification, No Income No Ratio, and No Income No Asset only up to 95% LTV/CLTV is allowed."). (3) Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .316 April 13, 2010 Subcommittee Hearing at 17. 1. Rank Credit Rating Agencies by Accuracy. . . . . . . . . . . . . . . . . . . . . . . . . . . . .316 April 13, 2010 Subcommittee Hearing at 17. 2. Help Investors Hold CRAs Accountable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .316 April 13, 2010 Subcommittee Hearing at 17. 3. Strengthen CRA Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .316 April 13, 2010 Subcommittee Hearing at 17. 4. Ensure CRAs Recognize Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .316 April 13, 2010 Subcommittee Hearing at 17. 5. Strengthen Disclosure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .317 11/17/2005 WaMu internal memorandum, "So. CA Emerging Markets Targeted Loan Review Results," JPM_WM01083051, Hearing Exhibit 4/13-22a. 6. Reduce Ratings Reliance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .317 11/17/2005 WaMu internal memorandum, "So. CA Emerging Markets Targeted Loan Review Results," JPM_WM01083051, Hearing Exhibit 4/13-22a.
¶VI. INVESTMENT BANK ABUSES:
¶CASE STUDY OF GOLDMAN SACHS AND DEUTSCHE BANK.. . . . . . . . . . . . . . . .318 Id.
¶A. Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .321 Id. at JPM_WM02481940.
(1) Investment Banks In General.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .321 Id. at JPM_WM02481940. (2) Roles and Duties of an Investment Bank: Market Maker, Underwriter, Placement Agent, Broker-Dealer.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .322 Id. at JPM_WM02481936. (3) Structured Finance Products. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .325 Id. at JPM_WM02481943.
¶B. Running the CDO Machine: Case Study of Deutsche Bank. . . . . . . . . . . . . . . . . . . .330 11/18/2005 email from Cheryl Feltgen to Nancy Gonseth on the Risk Mitigation Team and Tim Bates, JPM_WM03535695, Hearing Exhibit 4/13-23a.
(1) Subcommittee Investigation and Findings of Fact. . . . . . . . . . . . . . . . . . . . . . . . . . .333 See, e.g., 3/2006 WaMu email chain, JPM_WM03985880-83. (2) Deutsche Bank Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .334 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 1, Hearing Exhibit 4/13-24. (3) Deutsche Bank's $5 Billion Short . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .337 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 1, Hearing Exhibit 4/13-24. (a) Lippmann's Negative Views of Mortgage Related Assets. . . . . . . . . . . . . . . . .337 4/4/2008 WaMu Memorandum of Results, "AIG/UG and OTS Allegation of Loan Frauds Originated by [name redacted]," at 1, Hearing Exhibit 4/13-24. (b) Building and Cashing in the $5 Billion Short. . . . . . . . . . . . . . . . . . . . . . . . . . .341 Id. (4) The "CDO Machine" . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .346 1/7/2008 OTS Asset Quality Memo 22, "Loan Fraud Investigation," JPM_WM02448184, Hearing Exhibit 4/13- 25. (5) Gemstone.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .350 Subcommittee interview of Brian Minkow (2/16/2010). See also 2005 "President's Club 2005 - Maui, Awards Night Show Script," Washington Mutual, Home Loans Group, Hearing Exhibit 4/13-63a (stating Mr. O'Brien and Mr. Minkow had produced $1.2 billion in loans in 2005). (a) Background on Gemstone. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .350 Subcommittee interview of Brian Minkow (2/16/2010). See also 2005 "President's Club 2005 - Maui, Awards Night Show Script," Washington Mutual, Home Loans Group, Hearing Exhibit 4/13-63a (stating Mr. O'Brien and Mr. Minkow had produced $1.2 billion in loans in 2005). (b) Gemstone Asset Selection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .353 5/12/2008 "WaMu Significant Incident Notification (SIN)," JPM_WM05452386, Hearing Exhibit 4/13-30. (c) Gemstone Risks and Poor Quality Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .357 Id. at 1. (d) Gemstone Sales Effort. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .363 See 8/2006 "Option ARM Credit Risk," WaMu presentation, at 3, Hearing Exhibit 4/13-37; 10/17/2006 "Option ARM" draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38. (e) Gemstone Losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .371 See April 13, 2010 Subcommittee Hearing at 50. (6) Other Deutsche Bank CDOs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .372 6/5/2006 "e-Flash" from Steve Stein to Retail Production Sales, JPM_WM03246053. (7) Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .374 8/17/2006 "e-Flash" from Steve Stein, Arlene Hyde, and John Schleck to Production and Operations, JPM_WM03277786-87.
¶C. Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs. . . . . . . . . .376 8/31/2006 "e-Flash" from Mary Ann Kovach to Consumer Direct, JPM_WM03077747.
(1) Subcommittee Investigation and Findings of Fact. . . . . . . . . . . . . . . . . . . . . . . . . . .376 8/31/2006 "e-Flash" from Mary Ann Kovach to Consumer Direct, JPM_WM03077747. (2) Goldman Sachs Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378 See, e.g., 11/13/2006 "e-Flash" from Mary Ann Kovack to Consumer Direct, JPM_WM03077089-90. (3) Overview of Goldman Sachs Case Study. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .382 Id. at 55; 3/2007 Washington Mutual Inc. 10-K filing with the SEC at 57. (a) Overview of How Goldman Shorted the Subprime Mortgage Market. . . . . . . .382 Id. at 55; 3/2007 Washington Mutual Inc. 10-K filing with the SEC at 57. (b) Overview of Goldman's CDO Activities.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .388 10/17/2006 "Option ARM" draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38, chart at 2. (4) How Goldman Shorted the Subprime Mortgage Market.. . . . . . . . . . . . . . . . . . . . . .398 Id.; Subcommittee interviews of David Schneider (2/17/2010) and Cheryl Feltgen (2/6/2010). (a) Starting $6 Billion Net Long. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .398 Id.; Subcommittee interviews of David Schneider (2/17/2010) and Cheryl Feltgen (2/6/2010). (b) Going Past Home: Goldman's First Net Short. . . . . . . . . . . . . . . . . . . . . . . . . .404 Subcommittee interview of Cheryl Feltgen (2/6/2010). (c) Attempted Short Squeeze.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .425 See 6/11/2007 chart entitled, "Capital Markets Division Growth," JPM_WM03409858, Hearing Exhibit 4/13- (d) Building the Big Short. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .430 Id. (e) "Get Down Now".. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .440 3/24/2005 email from Kevin Gasvoda of Goldman Sachs to Christopher Gething, others, Hearing Exhibit 4/27-
¶iv
(f) Profiting from the Big Short: Making "Serious Money". . . . . . . . . . . . . . . . . . .444 11/7/2006 email from David Beck to David Schneider, Hearing Exhibit 4/13-50. See also 4/19/2006 "ABX Index – The Constituent Breakdown," prepared by Nomura Securities International Inc., http://www.scribd.com/doc/19606903/Nomura-ABX-Index-The-Constituent-Breakdown. (g) Goldman's Records Confirm Large Short Position. . . . . . . . . . . . . . . . . . . . . . .445 "WaMu subprime ABS delinquencies top ABX components," Reuters (3/27/2007), Hearing Exhibit 4/13-52. (i) Top Sheets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .446 7/10/2007-7/12/2007 excerpts from Standard & Poor's and Moody's Downgrades, Hearing Exhibit 4/23-99. (ii) Risk Reports.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .455 3/22/2007 WaMu Prospectus Supplement, "Washington Mutual Mortgage Pass-Through Certificates, WMALT Series 2007-OA3," at S-102, Hearing Exhibit 4/13-86b. (h) Profiting From the Big Short. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .466 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b.
¶(5) How Goldman Created and Failed to Manage Conflicts of Interest in its
Securitization Activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .474 12/28/2007 WaMu internal report, "Disclosure Management," JPM_WM02414318. (a) Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .477 2/27/2007 email from Youyi Chen to David Griffith, "Option ARM," JPM_WM03117796 ("David, we sell all 295+ margin and other OA and COFI, and KEEP the 4 categories going forward due mostly to non-salable reasons."). (i) Goldman's Securitization Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .477 2/27/2007 email from Youyi Chen to David Griffith, "Option ARM," JPM_WM03117796 ("David, we sell all 295+ margin and other OA and COFI, and KEEP the 4 categories going forward due mostly to non-salable reasons."). (ii) Goldman's Negative Market View. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .478 3/9/2007 WaMu Market Risk Committee Meeting Minutes, Hearing Exhibit 4/13-43. (iii) Goldman's Securitization Sell Off. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .481 4/10/2010 Subcommittee email from Brent McIntosh, Sullivan & Cromwell LLP, Counsel for JPMorgan Chase [Sealed Exhibit]. AA. RMBS Sell Off.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .481 4/10/2010 Subcommittee email from Brent McIntosh, Sullivan & Cromwell LLP, Counsel for JPMorgan Chase [Sealed Exhibit]. BB. CDO Sell Off. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .492 See 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405461, Hearing Exhibit 4/16-86 ("Under this Alliance Agreement with Fannie Mae, WaMu has agreed to deliver no less than 75% of eligible, conforming loans to Fannie Mae."); 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 ("5 years of 85%+ share with Fannie"). CC. CDO Marks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .503 See 7/5/2006 "Freddie Mac – WaMu Meeting," document prepared by WaMu, JPM_WM03200453, Hearing Exhibit 4/16-87 ("WM executed a majority share arrangement w/FRE [Freddie Mac], effective 4/1/05 thru 3/31/06; included in that arrangement was a market-leading opportunity to sell up to $21 billion of option ARMs to the FRE portfolio."). DD. Customer Losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .507 Id. (b) Goldman's Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .513 See "Freddie Mac Raises its Estimate of Errors," Associated Press (9/26/2003). (i) Conflicts of Interest Involving RMBS Securities. . . . . . . . . . . . . . . . . . . .513 See "Freddie Mac Raises its Estimate of Errors," Associated Press (9/26/2003). (ii) Conflicts of Interest Involving Sales of CDO Securities. . . . . . . . . . . . . .516 See 2004 10-K filing with the SEC. Fannie Mae paid the $400 million civil fine in May 2006, to settle accounting fraud charges brought by OFHEO and SEC. See also "Fannie Settles Fraud Charges," National Mortgage News (5/29/2006). AA. Hudson Mezzanine Funding 2006-1. . . . . . . . . . . . . . . . . . . . . . . . .517 April 13, 2010 Subcommittee Hearing at 105, Senator Coburn question to Mr. Rotella. BB. Anderson Mezzanine Funding 2007-1.. . . . . . . . . . . . . . . . . . . . . . .532 See "Washington Mutual CEO Kerry Killinger: $100 Million in Compensation, 2003-2008," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1h. CC. Timberwolf I. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .541 Subcommittee interviews of Brian Minkow (2/16/2010), David Schneider (2/17/2010), and Kerry Killinger (2/5/2010). DD. Abacus 2007-AC1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .560 Subcommittee interview of David Schneider (2/17/2010). (iii) Additional CDO Conflicts of Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . .574 "WaMu Board Shields Executives' Bonuses," Wall Street Journal (3/5/2008), Hearing Exhibit 4/13-67. AA. Liquidation Agent in Hudson 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . .574 "WaMu Board Shields Executives' Bonuses," Wall Street Journal (3/5/2008), Hearing Exhibit 4/13-67. BB. Collateral Put Provider in Timberwolf. . . . . . . . . . . . . . . . . . . . . . .588 Id. at 88.
¶(6) Analysis of Goldman's Conflicts of Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602
(a) Securities Laws. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .603 The interagency agreement is entitled, "Coordination of Expanded Supervisory Information Sharing and Special Examinations." During the time period of the Subcommittee's investigation, the 2002 version of the interagency agreement, signed by the FDIC, Federal Reserve, OCC, and OTS, was in effect. In July 2010, the federal financial regulators agreed to adopt a stronger version, discussed later in this Report. (b) Analysis .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 609 (i) Claiming Market Maker Status.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 609 (ii) Soliciting Clients and Recommending Investments. . . . . . . . . . . . . . . . . .613 The Home Loans presentation to the Board acknowledged that risks of the High Risk Lending Strategy included managing credit risk, implementing lending technology and enacting organizational changes. 4/18/2006 Washington Mutual Home Loans Discussion Board of Directors Meeting, at JPM_WM00690899, Hearing Exhibit 4/13-3. (iii) Failing to Disclose Material Adverse Information. . . . . . . . . . . . . . . . . . .615 See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001509, Hearing Exhibit 4/16-94 [Sealed Exhibit]. (iv) Making Unsuitable Investment Recommendations. . . . . . . . . . . . . . . . . .619 Id. An August 2006 WaMu internal presentation indicated that over 95% of its Option ARM borrowers were making minimum payments. See 8/2006 chart, "Borrower-Selected Payment Behavior," in WaMu internal presentation entitled, "Option ARM Credit Risk," JPM_WM00212646, Hearing Exhibit 4/13-37.
¶(7) Goldman's Proprietary Investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .624 See Thorson prepared statement, at 5, April 16, 2010 Subcommittee Hearing at 105. D. Preventing Investment Bank Abuses.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .636 7/22/2008 letter from OTS to FDIC, OTSWMS08-015 0001312, Hearing Exhibit 4/16-60.
¶(1) New Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .636 7/22/2008 letter from OTS to FDIC, OTSWMS08-015 0001312, Hearing Exhibit 4/16-60.
¶(2) Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .638 8/1/2008 email exchange among OTS officials, Hearing Exhibit 4/16-62. The FDIC had performed a capital analysis earlier in the summer and had been pushing for a downgrade for weeks. See 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59.
- Review Structured Finance Transactions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .639 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63. 2. Narrow Proprietary Trading Exceptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .639 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63. 3. Design Strong Conflict of Interest Prohibitions.. . . . . . . . . . . . . . . . . . . . . . . . .639 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63. 4. Study Bank Use of Structured Finance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .639 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63.
# # v
Wall Street and The Financial Crisis: Anatomy of a Financial Collapse
¶April 13,2011 For more information about this December 14 meeting, see discussion in Section C(4)(b), above.
¶In the fall of 2008, America suffered a devastating economic collapse. Once valuable securities lost most or all of their value, debt markets froze, stock markets plunged, and storied financial firms went under. Millions of Americans lost their jobs; millions of families lost their homes; and good businesses shut down. These events cast the United States into an economic recession so deep that the country has yet to fully recover.
¶This Report is the product of a two-year bipartisan investigation by the U.S. Senate Permanent Subcommittee on Investigations into the origins of the 2008 financial crisis. The goals of this investigation were to construct a public record of the facts in order to deepen the understanding of what happened; identify some of the root causes of the crisis; and provide a factual foundation for the ongoing effort to fortify the country against the recurrence of a similar crisis in the future.
¶Using internal documents, communications, and interviews, the Report attempts to provide the clearest picture yet of what took place inside the walls of some of the financial institutions and regulatory agencies that contributed to the crisis. The investigation found that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.
¶While this Report does not attempt to examine every key moment, or analyze every important cause of the crisis, it provides new, detailed, and compelling evidence of what happened. In so doing, we hope the Report leads to solutions that prevent it from happening again.