Kerry Killinger Chased Riskier Mortgages and Lost Washington Mutual

On September 25, 2008, federal regulators closed Washington Mutual Bank and transferred its banking operations to JPMorgan Chase for approximately $1.9 billion. The failed institution had about $307 billion in assets. Its customers could keep using their accounts, but the institution that Kerry Killinger had spent nearly two decades expanding had lost its independence in a single evening. The FDIC records the closure as the largest bank failure in its history. FDIC historical account

The transaction contained a distinction that the headline purchase price can obscure. JPMorgan Chase acquired deposits, assets and certain liabilities through the receivership; it did not buy the parent holding corporation intact. A banking franchise could continue operating under a new owner while investors were left with claims against the failed entities. That separation explains both the continuity customers experienced and the destruction that made Washington Mutual a case study in institutional failure.

Killinger’s story is therefore about more than the last days of a bank run. It concerns the earlier decision to make higher-risk mortgages a larger source of earnings, and the failure of internal and external controls to restrain that decision. The housing collapse exposed the weakness. The vulnerability had accumulated while the bank was still writing loans, reporting results and pursuing its expansion plans.

Killinger made a regional thrift into a national lender

Killinger joined Washington Mutual in 1982, became president in 1988 and took the chief executive position in 1990. The Senate’s subsequent investigation identified him as the central figure in its acquisition-led expansion during the 1990s. A business with roots in Seattle home lending became a large institution with banking, mortgage, commercial-property and credit-card operations. Senate investigation, Washington Mutual case study

Expansion changed the practical meaning of a lending decision. At a small lender, a weak underwriting practice can damage a limited portfolio. Across a national origination network, the same practice can be repeated by employees and intermediaries thousands of times. Growth increases the value of consistent controls because it increases the distance between senior management and the individual borrower whose income must support a loan.

The bank also participated in several stages of the mortgage business. Originating a mortgage creates a relationship with a borrower. Holding it exposes the lender to repayment risk. Selling it produces a different stream of revenue and transfers some exposure. Servicing it means collecting payments and administering the account. These activities can coexist inside one institution without carrying identical risks or incentives.

That distinction matters when assessing the appeal of scale. A large branch network can attract deposits, distribute products and support repeat customer relationships. A large mortgage operation can produce fees and interest income. Putting both under one corporate roof does not automatically make the mortgages safer. The strength of the deposit franchise and the quality of the loans remain separate questions.

Washington Mutual’s later failure should not erase the operating business that made it attractive to an acquirer. Nor should its earlier expansion be treated as proof that the later lending strategy was sound. Acquiring customers and evaluating borrowers require different judgments. Killinger’s record placed both judgments inside the same executive career, making it easy for confidence earned in one activity to accompany decisions in another.

Higher returns required a different mortgage mix

In a June 2004 strategy memorandum, Killinger set targets that included average return on equity of at least 18% and average earnings-per-share growth of at least 13%. The Senate report traces the development of a strategy that placed greater emphasis on higher-risk home loans. Its account connects the pursuit of stronger earnings with a deliberate change in the bank’s lending priorities. Senate report, strategic direction and lending strategy

An earnings target does not itself determine which borrower receives a mortgage. It does, however, establish the result that business managers are expected to deliver. If conventional lending cannot produce the desired growth at prevailing prices, management must accept slower growth, reduce costs, find another business or take additional risk. The choice becomes consequential when a higher promised yield is counted before the full cost of future defaults is known.

A mortgage’s interest rate is compensation for several things, including the possibility that the borrower will not repay. A higher rate can improve income when payments arrive as scheduled. It can also indicate that the lender has accepted a greater chance of loss. Comparing rates without adequately accounting for that second possibility makes a riskier portfolio appear more productive than it ultimately proves to be.

The timing creates a reporting problem. Revenue can arrive before the borrower encounters difficulty, while losses emerge later. During a favorable housing market, several years of apparent success may therefore coexist with deterioration in the underlying loan book. Managers do not need to falsify every result for those results to provide an incomplete picture of the strategy’s durability.

The relevant test is whether borrowers can repay under less forgiving conditions. A loan that works only when property values rise offers the lender a different proposition from one supported by verified income and manageable payments. Rising collateral values can conceal that difference because a troubled borrower may refinance or sell before a missed payment becomes a realized loss.

That is why the change in lending priorities belongs near the center of Killinger’s history. It was a decision about the source of future profits, with consequences that could remain partly hidden during expansion. The subsequent fall in house prices did not merely interrupt an otherwise unrelated growth plan. It challenged the assumptions on which the mortgage strategy depended.

The loan balance could rise while the borrower paid

One of Washington Mutual’s important mortgage products was the option adjustable-rate mortgage, commonly called an option ARM. These loans could permit a minimum payment below the interest accruing on the debt. The unpaid interest then increased the principal balance, a process called negative amortization. A customer could make the permitted payment and still owe more afterward. The Senate investigation examined the risks associated with these products and their underwriting. Senate report, option ARMs and lending practices

Consider the arithmetic in a hypothetical month. If interest of $1,500 accrues and the permitted payment is $1,000, the remaining $500 must still be accounted for. Adding it to principal increases the amount owed. The smaller payment helps the household’s immediate cash flow, but it does not reduce the economic cost of borrowing by the same amount.

That structure puts particular weight on how a lender assesses affordability. The introductory or minimum payment answers one question: what must the borrower send now? The payment required to cover interest and repay principal answers another: what does carrying this debt actually require? A sound assessment must address the obligations the customer will face over the life of the loan.

Negative amortization can also reduce the borrower’s cushion against a decline in property values. If the debt rises while the home’s value falls, both movements narrow the owner’s equity. Refinancing becomes harder precisely when the borrower may want to escape a larger payment. Selling the property may no longer produce enough money to discharge the mortgage and transaction costs.

This does not make every adjustable-rate mortgage equivalent, or every borrower using one incapable of repayment. The critical issues are the contract, the underwriting and the borrower’s resources. Washington Mutual’s case concerns the institutional consequences of making risky products central to a large lending operation without controls adequate to the exposure.

For a bank, those consequences extend beyond a single default. Many borrowers may depend on the same favorable conditions at once. A portfolio spread across numerous households can still be exposed to a common deterioration in housing prices, refinancing access or employment. Counting the number of loans provides little reassurance if the loans share the same weakness.

Supervisors identified weaknesses without stopping them

The FDIC’s inspector general later reported that Washington Mutual failed because management pursued high-risk lending with liberal underwriting standards and inadequate controls. Examiners had identified concerns, including management weaknesses and problems in single-family loan underwriting. The primary regulator, the Office of Thrift Supervision, did not secure timely corrections and maintained satisfactory safety-and-soundness ratings until significant losses appeared in 2008. FDIC inspector general testimony

That finding shifts attention from whether anyone noticed a problem to what happened after it was noticed. An examination can document a weakness without changing the transactions that create it. Until management alters the practice, limits the exposure or demonstrates a correction, the next loan may repeat the defect described in the previous report.

The supervisory structure added another complication. OTS served as the primary federal regulator, while the FDIC monitored risk as deposit insurer and backup supervisor. The inspector general described resistance to FDIC examination requests and procedural obstacles to independent enforcement. It also found that the bank’s insurance premiums did not adequately reflect the risks identified through FDIC monitoring. FDIC inspector general findings on oversight

The institutional problem was therefore larger than a shortage of information. Different agencies possessed responsibilities, assessments and powers that did not produce sufficiently forceful intervention. A warning has limited practical value if the organization receiving it can continue the activity while the agencies responsible for oversight disagree about access or the threshold for action.

Management remained responsible for the loans. Regulatory shortcomings did not select borrowers or determine the bank’s appetite for risk. But supervision was supposed to provide an independent check on those decisions. Washington Mutual’s history shows what can happen when an aggressive business strategy encounters a supervisory process that records concerns more effectively than it compels remedies.

A satisfactory rating can also influence other decisions because it becomes a compact signal about a complicated institution. The inspector general’s findings show the danger when that signal lags the underlying condition. Reports, ratings and insurance assessments need to respond to developing exposure; waiting for large losses means waiting until a portion of the risk has already become damage.

The final run removed the time to recover

In the eight business days beginning September 15, 2008, Washington Mutual suffered deposit outflows totaling $16.7 billion, according to an OTS fact sheet preserved in federal court filings. The document described limited funding sources and insufficient liquidity to meet obligations. It also recorded successive increases in loan-loss provisions: $1.6 billion in the final quarter of 2007, $3.6 billion in the first quarter of 2008 and $6 billion in the second. OTS fact sheet, reproduced in court records

Those figures describe two pressures working on different clocks. Rising provisions recognized worsening expectations for credit losses. Deposit withdrawals created a demand for money immediately. A bank can hold assets that will generate payments over many years while owing depositors funds they can withdraw now. A sudden withdrawal of funding forces it to bridge that timing gap under adverse conditions.

Selling assets can supply cash, but the price available during a crisis may be unattractive. Borrowing can supply cash if counterparties accept the collateral and the institution’s condition. New equity can absorb losses if investors are willing to provide it on workable terms. Each route depends on confidence that becomes harder to obtain as visible losses and withdrawals reinforce one another.

The distinction between capital and liquidity helps explain the speed of the ending. Capital provides capacity to absorb losses. Liquidity provides the means to make payments when due. Additional time might allow a bank to collect loans, sell a business or negotiate funding, but an institution that cannot meet immediate obligations cannot simply choose to wait for those possibilities.

The final run should therefore be read alongside the preceding credit deterioration. Focusing only on the withdrawals makes the collapse appear to be an isolated confidence event. Focusing only on bad loans misses the mechanism that forced closure on a particular date. Washington Mutual faced a damaged mortgage business and a rapidly shrinking supply of funding at the same time.

Killinger was dismissed in September 2008, before the seizure. His departure ended his executive tenure but could not remove the existing loan exposures or restore departed deposits. Leadership changes can alter future decisions; they do not rewrite contracts already signed. By then, the institution needed a solution to its balance sheet and funding problems within a rapidly narrowing period. Senate report, management history

Chase bought the banking operation, leaving investors behind

JPMorgan Chase’s announcement specified that the purchase excluded the banks’ senior unsecured debt, subordinated debt and preferred stock. It also excluded the parent holding corporation’s assets and liabilities and those of its nonbank subsidiaries. The buyer gained entry into important markets, including California, Florida and Washington State, and a combined network of 5,400 branches across 23 states. JPMorgan Chase acquisition announcement

The approximately $1.9 billion payment should consequently be understood as the consideration for a specified receivership transaction. It was not a conventional stock-market valuation of everything once associated with Washington Mutual. The buyer assumed substantial obligations as well as acquiring assets, while particular investor claims remained outside the transaction. Comparing the payment directly with total assets leaves out that structure.

The attraction to Chase also demonstrates why a failed bank can contain a valuable operating franchise. Branch locations, deposits and customer relationships can be useful to an institution able to support them. Their continued usefulness does not establish that the former owner’s combination of assets, liabilities and exposures was sustainable. A business can retain customers while the corporate structure carrying it fails.

For account holders, the transfer provided continuity. The FDIC’s customer guidance said loan payments should continue and contractual loan terms would not change because of the transaction. It separately explained that equity and specified unsecured debt claims had not been acquired. The resolution preserved ordinary banking functions without giving every class of claimant the same outcome. FDIC Washington Mutual resolution guidance

The FDIC also reports that the transaction imposed no cost on its Deposit Insurance Fund. That statement describes the result for a particular insurance fund. It does not measure all losses associated with the failure, the experience of shareholders or the hardship of borrowers whose mortgages became unaffordable. Keeping those categories separate is essential to understanding what the resolution accomplished. FDIC historical account

Killinger’s lasting business case is the connection between ambition, product design and the ability to enforce limits. Growth made Washington Mutual larger; the mortgage strategy determined a consequential part of what that larger institution owned and sold. Once credit losses and funding withdrawals converged, the useful branch franchise could be transferred, but the independence accumulated over years of expansion could not be preserved.

Frequently asked questions

Who was Kerry Killinger?

He was Washington Mutual’s chief executive from 1990 until September 2008 and led its acquisition-driven expansion.

Why did Washington Mutual fail?

Regulatory investigators identified high-risk mortgage lending, weak underwriting and inadequate controls. Heavy deposit withdrawals then produced an acute liquidity crisis.

Did JPMorgan Chase buy all of Washington Mutual?

No. It acquired banking operations through the FDIC receivership, with specified liabilities and the parent holding corporation excluded.