Nothing Is Too Big to Fail

How the Last Financial Crisis Informs Today

Kerry Killinger, Linda Killinger

• Publisher: RosettaBooks
• Year: 2021
• ISBN:
  9780795353031
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

No institution, government, or country is "too big to fail." A behind-the-scenes account of what led to the 2008 crisis—and may soon lead to a bigger one. Written by two bank executives with firsthand experience of several financial crises, Nothing is Too Big to Fail holds a stiff warning about the future of finance and social justice—revealing how the US government's fiscal and monetary policies are creating asset and debt bubbles that could burst at any time. The COVID-19 pandemic is just one of many risks that could derail our highly leveraged and fragile economic system. The authors also tell how government actions and an unregulated shadow banking system are leading to inequitable distribution of wealth, destroying the middle class, reducing trust in government, and accelerating racial injustice. No institution, government, or country is "too big to fail." This book offers lessons learned from past crises and recommended actions for business and government leaders to take today to return our economic system and our democracy to a safer trajectory.

1

“Too Clubby to Fail”: Wall Street Banks Win, Thrifts and Community Banks Lose

2008

There are days that are uneventful and flow together endlessly. So many days, you can’t remember the details. But then there are days that will stay with you forever, days you can never forget, days that will change your life forever. September 25 was always a special day for Linda, because it was the birthday of her only child. She had just given him a brief call. He was busy working as a paralegal, saving money for law school. After the call, Linda and Kerry turned on the TV to watch the news and heard the announcement that was impossible to believe. The sixth-largest bank in the country, Washington Mutual, with over $300 billion in assets, had been seized and sold to JPMorgan Chase for the bargain price of $1.9 billion. The seizure had occurred during the 119th anniversary year of the incorporation of the bank.

This improbable seizure did not fit the facts we knew. Kerry had just retired from the bank three weeks earlier. When he retired, Washington Mutual had over $50 billion of excess liquidity, and over $11 billion of capital had been raised in the last 10 months, so capital was significantly above regulatory requirements. Loan portfolios were performing better than the industry, and the bank didn’t have any formal regulatory directives or enforcement actions. The bank’s holding company had over $30 billion of assets, some of which could have been down-streamed to the bank. With all those assets and liquidity, there should have been no reason for the seizure of the bank or the bankruptcy of the holding company. The bank’s residential mortgage lending had been dramatically decreased in the last few years, and the growing retail banking operation, credit cards, and multifamily lending were highly profitable and the bulk of the bank’s business.

There are not many CEOs of a Fortune 50 company who have seen a crisis coming and within a couple of years, dropped the core product (home lending) by 74 percent, replaced the revenues with a diversified portfolio of new products, hired a new management team, and continued to achieve record revenue and profits. Kerry felt confident these actions positioned the bank to face the coming crisis.

However, when the regulators let Lehman fail, most banks, including Washington Mutual, suffered deposit losses. But those losses had stabilized at Washington Mutual, and the Federal Home Loan Banks of San Francisco and Seattle offered billions of additional liquidity in case it was required. The executives at the bank had submitted a plan to Treasury that would add billions of liquidity and assets to the bank. They had until Sunday, September 28, to get approval of the plan. It was only Thursday. We couldn’t think of an example when the regulators had seized a 3-rated bank and they had rarely seized a bank on a Thursday—it was always Friday. What was the rush?

Well-established regulatory protocols appeared to be ignored in an effort to get a sale completed before additional capital or liquidity could be brought into the bank. Kerry understood why the board had asked him to retire earlier that month. Nearly all the large-bank CEOs in the country had been retired or terminated after all banks experienced record increases in loan losses, record losses in earnings, and deep plunges in stock prices. After retiring from Washington Mutual, Kerry had continued on with life, fielding numerous calls from employees keeping him posted on the activities of the bank and also fielding calls from executives with offers to join their firms or boards.

Hearing that Washington Mutual was seized stunned and scared Kerry. He knew it meant the entire financial system was about to collapse. Over the past four years, Kerry had repeatedly warned investors, regulators, and the Federal Reserve that the housing collapse could have a substantial effect on the economy. He pleaded with the Federal Reserve to inject liquidity into the system and was astounded when regulators made the fatal mistake of letting Lehman Brothers fail. Kerry was angry at the continual incompetence of the government officials.

The financial crisis could have been avoided. The seizure of Washington Mutual, the failure of thousands of thrifts and community banks, the loss of millions of jobs and homes should not have happened. Kerry went through his mental trap line—was there anything he could have done differently?

Should he have cut residential mortgage loans even further? Maybe, but he made deeper cuts than any of the large banks and laid off fifteen thousand mortgage employees. Should he have originated any subprime loans at all? Maybe not, but regulated banks were pressured to have substantial portfolios of LMI loans to earn “outstanding” CRA ratings. Washington Mutual’s subprime loans averaged about 5 percent of the loan portfolio with loan losses much lower than the industry. Should he have eliminated adjustable-rate loans and only offered fixed-rate residential loans? Maybe, but customers wanted a full range of products and adjustable-rate loans like option ARMs were given to prime customers and had very low default rates similar to fixed-rate loans. Fixed-rate loans made up 70 to 80 percent of Washington Mutual’s residential loan originations during the 2000s.

Should he have spent tens of millions of dollars lobbying Congress, like Wall Street did? Maybe, but he felt if you followed the rules and exhibited strong ethics, you didn’t need to bribe Congress. That strategy worked for decades because the bank never had any formal regulatory actions, fines, or penalties. Did he always have the right people in the job? Sometimes not, but when that happened, he quickly made changes. Early in the decade, he recruited some of the best and most experienced people in the industry. Should he have converted to a commercial banking charter earlier? Maybe, but large commercial banks were having even more problems.

Should he have raised more capital? He did and in July 2008, Washington Mutual was the most highly capitalized large bank in the country, the first large bank to be Basel II compliant and regulators and experts agreed its $50 billion-plus in liquidity would carry the bank through any serious downturn.

We started getting phone calls and emails from former employees. Nearly all the executives had just heard about the seizure on the news and were shell-shocked. We were very concerned what the seizure meant for the tens of thousands of employees who would lose their jobs and their savings. Between phone calls, Kerry paced the room and carefully reviewed the events of the last nine months, trying to process if there was anything he could have done differently. He looked back to the beginning of the year.

The January 2008 investor conferences in New York City were grim. Nearly all the banks were suffering record losses from their deteriorating loan portfolios, and bank stock values were plummeting and banks were desperately seeking more capital and liquidity. Kerry had been warning the Federal Reserve (Fed) for four years about a downturn and the need for liquidity in the system and was once again using the conferences to warn investors and regulators of the deepening financial crisis. He continued to be frustrated the Fed was so slow to act. He told investors:

Housing prices were correcting in a fairly orderly manner until the middle of 2007, when the capital markets suddenly froze. In a very brief period, the consumer’s ability to obtain financing was severely curtailed. Unfortunately, the Federal Reserve and the [federal] government were very slow to acknowledge deteriorating market conditions, because their economists were forecasting only a brief slowdown in housing followed by a quick recovery.

Kerry continued to be frustrated by the inaction of Fed chair Bernanke. Bernanke was scholarly in an ivory tower way, but he didn’t have practical capital market or business experience. As a result, early on, when there were discussions about the housing market, he did not understand what made the mortgage markets work and how sophisticated capital market products would react when liquidity dried up in the system. Bernanke would always respond that he “was more concerned about the potential of inflation than about the decline of the economy.”

Fed chair Bernanke and others even ignored warnings by Nobel Laureate economist Dr. Robert Shiller. In Shiller’s 2008 book The Subprime Solution, he detailed his own efforts to warn Bernanke, the OCC, and the FDIC about the speculative housing bubble. Shiller felt he was viewed as “an extremist who deserved a skeptical response.” Shiller, like Kerry, believed if Bernanke had injected liquidity into the system in the fall of 2007, the depths of the crisis could have...

Table of contents

• Cover
• Half Title Page
• Title Page
• Copyright
• Contents
• Introduction
• 1 “Too Clubby to Fail”: Wall Street Banks Win, Thrifts and Community Banks Lose
• 2 Increased Risk Taking Due to Deregulation
• 3 Deregulation, Politics, and Criminal Prosecutions
• 4 The Four Major Waves of Change in the 1990s That Laid the Groundwork for the 2008 Financial Crisis
• 5 Washington Mutual in the Age of Consolidation of the Financial Industry
• 6 Record Profits and the Stunning Growth of Shadow Banking1
• 7 Record Banking Profits and Growth, but There Is a Canary in the Mine
• 8 The Financial Crisis Hits
• 9 The Aftermath of the Financial Crisis
• 10 Part One: Investigations and Lawsuits: 2010
• 11 The Fast Buildup of the Next Shadow Banking System
• 12 The Makings of the Next Financial Crisis
• 13 Recommendations to Avoid the Next Financial Crisis
• Afterword: COVID-19 Strikes
• Photo Gallery
• Acknowledgments
• Glossary
• Timeline for Residential Home Lending
• Notes
• Index
• About the Authors