The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American Historyby Kirsten Grind
During the most dizzying days of the financial crisis, Washington Mutual, a bank with hundreds of billions of dollars in its coffers, suffered a crippling bank run. The story of its final, brutal collapse in the autumn of 2008, and its controversial sale to JPMorgan Chase, is an astonishing account of how one bank lost itself to greed and mismanagement, and how the
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During the most dizzying days of the financial crisis, Washington Mutual, a bank with hundreds of billions of dollars in its coffers, suffered a crippling bank run. The story of its final, brutal collapse in the autumn of 2008, and its controversial sale to JPMorgan Chase, is an astonishing account of how one bank lost itself to greed and mismanagement, and how the entire financial industry—and even the entire country— lost its way as well.
Kirsten Grind’s The Lost Bank is a magisterial and gripping account of these events, tracing the cultural shifts, the cockamamie financial engineering, and the hubris and avarice that made this incredible story possible. The men and women who become the central players in this tragedy— the regulators and the bankers, the home buyers and the lenders, the number crunchers and the shareholders—are heroes and villains, perpetrators and victims, often switching roles with one another as the drama unfolds.
As a reporter at the time for the Puget Sound Business Journal, Grind covered a story set far from the epicenters of finance and media. It happened largely in places such as the suburban homes of central California and the office buildings of Seattle, but Grind covered the story from the beginning, and the clarity and persistence of her reporting earned her many awards, including being named a finalist for the Pulitzer Prize and the Gerald Loeb Award. She takes readers into boardrooms and bedrooms, revealing the power struggles that pitted regulators at the Office of Thrift Supervision and the FDIC against one another and the predatory negotiations of investment bankers and lawyers who enriched themselves during the bank’s rise and then devoured the decimated bank in its final days.
Written as compellingly as the finest fiction, The Lost Bank makes it clear that the collapse of Washington Mutual was not just the largest bank failure in American history. It is a story of talismanic qualities, reflecting the incredible rise and the precipitous collapse of not only an institution but of trust, fortunes, and the marketplaces for risk across the world.
"An eye-opening book."—Booklist
"If indeed this book had been fiction, it would have been branded unrealistic, outlandish, and out of the realm of reality. It is, however, a factual account with endnotes, references, and detailed documentation of sources used. It is an incredible story... The book reads very much like a novel and holds the reader’s interest."—William J. Taylor, ABA Banking Journal
"A fantastic story... Every American should read about it..."—John Hockenberry, "The Takeaway"
"Almost a Barbarians-esque view..."—Andrew Ross Sorkin, "Squawk Box"
"Wall Street Journal reporter Kirsten Grind deftly restores the 'lost bank' to its rightful place in the annals of financial disasters... The clarity and humility of the writing is refreshing."—Tom Braithwaite, The Financial Times
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FRIEND OF THE FAMILY
Not only will we succeed financially, we will succeed as human beings.
—Lou Pepper, speech to Washington Mutual employees
In 1951, Lou Pepper arrived in Seattle after World War II with no job prospects and lackluster interest from the law firms where he tried to find work. Now, thirty years later, he held the position of senior partner of a firm with sixty lawyers, a title that he, as a boy growing up in a farming town during the Great Depression, could hardly have fathomed. He had a lovely wife named Mollie and four children, almost all grown up. At fifty-seven, he was nearing retirement.
But now, in the summer of 1981, Pepper had a problem. He was beginning to realize, as he sat in a stuffy conference room at the Westin Hotel downtown, that the problem was about to become his own. Sitting around a boardroom table, as the July sun poured in through one of the windows, were an impressive array of men running Seattle businesses. Many of them would only grow more powerful over the next two decades. Among the men: an executive of Boeing; the head of the local power company, who would later represent the city’s baseball team; and the president of a college, who would be elected a U.S. senator.1
The men went around the room discussing their schedules. All of them were busy. No one had time to run a scrappy little bank called Washington Mutual. As trustees,* however, they were in a desperate situation. The bank, after nearly 100 years in existence, was on the verge of failure. It was losing $5 million in capital a month, a rate that would put it out of business within three years, assuming the situation didn’t get much worse.2 Faced with this prospect, Washington Mutual’s senior management team froze. Instead of finding ways out of the problem, they did nothing at all.
None of the trustees, and especially not Pepper, wanted to lose the bank. Pepper had developed a fondness for Washington Mutual. It had been his client for much of the last three decades at his law firm, Foster Pepper & Riviera.† He had spent countless billable hours working on its behalf. He remembered the first time he had walked into a courtroom sometime in the 1950s to file a foreclosure. The judge had looked down at him and said: “The one thing I know is that if you’re here to foreclose a mortgage from Washington Mutual, you’ve done everything you can to help them save their home. My parents almost lost their house in the thirties and Washington Mutual made it possible for them to keep it.”
It was one thing to work with a bank and another to run it, though. But as the trustees went around the table, Pepper was the only one of the prestigious group who could pull himself away from his day job. He was also the only one with experience in banking, even though he liked to tell people he didn’t “know his ass from third base.” As Washington Mutual’s outside general counsel, he knew how to deal with the federal regulators in Washington, D.C., and had once outsmarted the Federal Deposit Insurance Corp. when it stood in the way of a merger at Washington Mutual. The National Law Journal rated him as one of the top twenty banking attorneys in the country.3 “I will do this,” Pepper told the board, “but only for six months.”
The meeting ended. Pepper called his nephew, Bill Longbrake, who happened to be working with one of the regulatory agencies in Washington, D.C. “I have never managed anything and I’m now the CEO,” he told Longbrake. One of the trustees sent a letter to Pepper’s children, explaining the situation. “They were totally confused,” said Pepper later. “Dad’s been a lawyer, now he’s tied up with this other thing and this other thing is a thing that’s losing a lot of money?” His wife Mollie’s reaction was, in typical fashion, supportive. “There are a bunch of new people I’ll get to meet,” she proclaimed. Pepper’s friends and family members sent letters. Several questioned his sanity. Others were supportive. “Save the bank,” they wrote.
If there was one thing that Pepper did know instinctively, it was people. He knew that the employees of Washington Mutual would have two questions for him when he showed up the next day at its offices: “What the hell are you doing here?” and “What are we supposed to do?” Pepper decided to write a speech. He had the night after the trustee meeting to prepare. When he walked into the office the next morning, the chief financial officer quit. Pepper consulted with the head of the communications department about how to handle the CFO’s resignation and his own arrival announcement. That person resigned as well.
With trepidation, Pepper called all the senior managers into the bank’s small boardroom and gave his speech anyway. When he looked out across them, they looked back with uncertainty on their faces. No wonder. Not only was Washington Mutual in trouble, the whole banking industry seemed about to collapse during the summer of 1981. No one seemed to know what to do about it. Across the country, thousands of banks like Washington Mutual were losing money just as rapidly, and some were beginning to fail. Interest rates had shot up past 20 percent, forcing the banks to pay a high rate on certificates of deposit. At the same time, banks were receiving back only a low interest rate payment from loan customers, most of whom had 30-year fixed-rate mortgages. The difference between those two numbers was what caused Washington Mutual, and 80 percent of the banks like it across the country, to bleed so much money. Meanwhile, new customers, scared of the much higher rate, didn’t want to take out a mortgage. The situation was so bad that Washington Mutual had stopped making mortgages for several months. Over the next few years, the federal government would step in and rescue more than four dozen banks.4
Washington Mutual had another problem: Hawaii. Its former president Wally Eldridge had decided Hawaii was the next frontier, promising several developers of large condominium complexes that Washington Mutual would supply the mortgages, to the tune of tens of millions of dollars. It was a promise the bank couldn’t keep. In 1978, Washington Mutual had made the most money it had ever brought in during one year, ever: $18 million. Only three years later, it would lose $32 million.
• • •
Pepper stood at the head of the boardroom at Washington Mutual, all eyes focused on him. He held several sheets of paper on which he had scrawled his speech. He was nervous—this was his first time as head of a company. Usually, he kidded around with people as a way to make them relax. Sometimes people found his sense of humor a bit odd, but they usually just laughed along with him because he himself was laughing so much. This, however, was no time for joking. The managers were all worried about the potential collapse of their company. “They’re probably wondering why I was chosen as CEO,” Pepper thought to himself.
“I’m not a banker,” he admitted to the group. But, he added, he had worked closely with the last four chief executives and, as a lawyer, had wrestled with the FDIC. He reassured Washington Mutual’s managers that they were doing a great job. “I don’t think we’ll have to worry about operating this place,” he said. Pepper wanted the bank to stick with its original mission, thought up 90 years ago by its founders. “We’re going to be the best place for a person to put aside money for future use,” Pepper said. “If there is something else our customers should have available to help them do that, we will try and provide it.”
Pepper knew quite a bit about savings. He also knew that banks could become a scary business if not run properly. Born in a farmhouse in Illinois, he grew up in a town of 110, not counting his family, located between patches of forest, long stretches of fields growing oats, corn, and alfalfa and seven lakes of varying sizes. In Trevor (pronounced TREE-vor), Wisconsin, there were five major businesses where you could work if you weren’t a farmer—the mostly vacant stockyards, the sauerkraut factory that opened only seasonably, a tile factory with sporadic hours, a blacksmith shop that later burned down, and an icehouse. Dahl’s General Store sold sugar and flour and some meat. Only the owners of the six local taverns made real money, and they all became less profitable after Prohibition ended. Some residents in Trevor had no jobs, although Pepper later recalled that no one paid attention to who received relief and who didn’t.
For $25 a month, Pepper’s family rented a two-story house adjacent to the railroad tracks that came with a barn and a chicken house. Pepper’s mother ran the post office, conveniently located in the front room of the family’s house. His father sold farm products and spices, door to door, around the county. Both parents had mastered the art of stretching money. Everyone’s mother could repatch clothing, but Pepper’s could repatch so well that it became hard to tell which had been the original garment. When the family went out occasionally for ice cream, it cost 25 cents because ice cream cost a nickel a scoop, and while there were six family members, Pepper’s mother didn’t like it. Only after the war did she claim to develop a taste for it. “A small town in the Great Depression is a great place to learn frugality,” Pepper said later.
Pepper witnessed firsthand the perils of banking when, in 1932, his sister Ruth turned eighteen and planned to move to upstate Wisconsin to attend teaching college. That Ruth, as a woman, was going to college at all was unusual. Pepper’s parents placed a high premium on education. They wanted all four children to go to college, including Pepper’s three older sisters. When Ruth left, Pepper was an eight-year-old attending elementary school classes in a two-room schoolhouse, soon to become a one-room schoolhouse after county budget cuts. The eighteen kids in Pepper’s school sat at individual desks and moved each year farther to the back of the room, as they grew taller and progressed in grades. Pepper liked the one-room schoolhouse because he could keep his ear tuned to the higher grades if he wanted and so could learn more, earlier.
Ruth, like her sisters, made money for her college tuition by waiting tables in the nearby homes of residents living on the lake. These people served dinner and lunch to tourists, or city dwellers on their Sunday drives. Ruth saved all the change she collected in tips to put toward her tuition of $21 a semester. She placed the money in Silver Lake State Bank, located about five miles away in the larger town of Silver Lake. One day Silver Lake State Bank shut down. It was one of thousands of banks that abruptly failed during the Great Depression. Because the government hadn’t yet approved deposit insurance, Ruth lost everything. Not long after, another community bank across the border in Illinois failed. This time the bank took with it the money tied up in Pepper’s grandfather’s estate. In both cases, the banks’ assets were liquidated; some of the money was recovered, but only a portion.
In 1981, in the spirit of his upbringing, Pepper set about saving money at Washington Mutual. The bank that Pepper inherited had about $2 billion in assets and 35 branches scattered across Washington State, mostly in the leafy neighborhoods of Seattle.5 On average, Washington Mutual had added only one branch every three years for most of the last century. “They were ponderous,” said one former trustee and board member. “Mostly they were poking along, doing fine.” Inside the branches, tellers waited behind long wooden counters, and customers who wanted to take out a loan sat in chairs upholstered in mossy green and faded gold undertones. Muted landscape paintings hung on beige walls. Some branches were located in aging brick buildings; others were outfitted with drive-through windows, the newest fad in banking. Banks had only just started adding ATMs, and in fact, one of Pepper’s more notable jobs as Washington Mutual’s general counsel had been to clear the way for the country’s first stand-alone, shared deposit machine, a concrete and stone structure hooked up to a computer system. It took up an entire air-conditioned room. Sometimes, if the temperature got too hot outside, the ATM, or “Exchange,” as it was called, would accidently spit out money, a kink that was eventually worked out.6
If the bank had aged, its customers weren’t far behind. Most of them were over fifty-five. Like Pepper, they had grown up during the country’s worst financial crisis. They were big savers. Many had taken out their first bank account with Washington Mutual through a program the bank had launched in the 1920s, encouraging children to learn about finances. Those students brought nickels and dimes they’d collected to school, and a volunteer parent would gather the money and bring it to the nearest bank branch. As they got older, those kids became real customers who carried what was known as a passbook, a ledger that looked like a slightly large passport and was common at most banks. The Washington Mutual teller ran the passbook through a cranky machine each time the customer deposited or withdrew money, stamping it with a record of the transaction. The machine broke down regularly. Washington Mutual executives often wondered how the bank would fare as its customers aged. What would happen when they died? “They’ll leave their money to their kids,” thought one senior manager at the time. “And their kids are not our customers.”
Washington Mutual had earned a good reputation locally, but almost no one outside the Pacific Northwest had ever heard of it. That wasn’t unusual. Most bank customers across the country kept money at smaller, local institutions. The financial giants, including the eventual Washington Mutual itself, didn’t yet exist. The competition was the other community bank down the street. In the early 1980s, federal and state laws restricting interstate banking prevented financial institutions from expanding outside their home state, so there wasn’t much potential to grow much bigger anyway. Washington Mutual was one of only about 200 banks that had assets of more than $1 billion, less than 2 percent of all banks. In 1994, the federal government passed legislation allowing bank holding companies to buy banks in other states—presuming the acquiring bank was healthy. Soon the number of banks with more than $1 billion in assets doubled.7 And the banks would only grow much, much larger.
• • •
Pepper would eventually lay off about fifty employees at Washington Mutual to save money, but he first sent a memo to the entire staff. He hoped to signal that hard times were coming as the bank cuts costs, but he also wanted to raise morale. The memo reflected Pepper’s personality: serious and teasing, in rapid and alternating succession. Without knowing it, Pepper also set in motion the thriftiness that would later distinguish Washington Mutual from its competitors.
The memo concerned plants. “All head office staff,” Pepper wrote. “It is necessary to institute some austerity at Washington Mutual. We have started small by removing some of the lovely plants we had in our non-public areas and the big plants from the fourth floor offices.”8
Washington Mutual’s headquarters in downtown Seattle, a columned building with the bank’s trademark W stamped on top, had only four cramped floors. The ground floor held the bank’s largest branch, a grand space where an older, well-dressed greeter was stationed. The fourth floor was known as the executive suite, but that was a loose description. Employees referred to it as “walnut heaven” because the office walls were movable wood panels that could be rearranged if necessary. The panels reached from floor to ceiling and came with doors but not windows. Pepper, as the chief executive, had the best office. It had two real walls on one corner of the floor with two wide windows. On the rare clear day, Pepper could see Mount Rainier, Washington State’s well-known volcano, fifty miles away.
“We now need to reduce the number of plants throughout the head office departments,” Pepper continued in his memo. “The bank needs people more than a demonstration of its ability to grow ficus and palms. Our investment in them is equal to salaries of six employees for one year. If there is a plant in your work area that you’ve become attached to (or just sort of fond of) and it is marked for removal, you have several choices. 1. You can buy the plant at whatever the bank will get for it; 2. You can petition for a commutation of its sentence; remember, it must be both a wanted and a needed plant; 3. We can hold an appropriate farewell party for it. Can you think of other areas of cost cutting that don’t hurt our services? Please let me know.” Within a few days, employees had gathered the plants and piled them in a heap in the middle of the executive floor.
Six months passed, and then six more. After eighteen months, and two extensions of his law firm leave, Pepper resigned from the law firm and gave up pretending that he was only a temporary chief executive. In early 1983, he took Washington Mutual public, raising about $75 million.9 It was, in his estimation, the only way to bring in enough money to save the bank. As a mutual bank, Washington Mutual was owned by its depositors, a structure not unlike that of a modern-day credit union. After it went public, Washington Mutual became a savings bank owned by its shareholders. (Both mutual and savings banks are known as “thrifts,” because they deal with consumers, rather than businesses like commercial banks.) Pepper converted bank charters through a Washington State law that he himself had drafted as an attorney. The move also gave Pepper the flexibility to expand into other lines of businesses.
But money and flexibility weren’t the only issues he faced. Pepper needed people to help him understand the increasingly complicated task of running a bank. Washington Mutual was now expected to invest in securities, hedge interest rate risk, and do “all kinds of things I didn’t understand at all,” Pepper said later. Banks had started hedging after the recent spike in interest rates, which pushed so many banks toward failure. If rates spun out of control again, the banks wouldn’t lose as much money. They started buying securities backed by mortgages, or car loans or credit card loans, or other strange new products created by Wall Street. The income from those products would, theoretically, offset any losses caused by fluctuating interest rates. Pepper wasn’t alone in his confusion. Even the best accountants didn’t fully understand the new secondary market. Until then, a mutual bank like Washington Mutual operated simply. It took customer deposits and made mortgages, and it could make only as many mortgages as customers brought in money.
Hiring wasn’t easy. Even though it was no longer so sickly, Washington Mutual was still suffering. It had lost $19 million just before it went public.10 Who wanted to work at a company that was losing so much money? It was the same question everyone asked Pepper when he took the job.
What Pepper didn’t realize was that he himself provided the incentive. Would-be executives who interviewed at Washington Mutual found someone who looked like their grandfather, with a wide, shiny forehead, round glasses, and lots of white hair. While he swore occasionally, he spoke softly and considered himself shy, even though no one else would ever have described him that way. Pepper’s smile stretched across his whole face, pushing out his cheeks and lighting up his eyes. He was lean, typically dressed well in a suit, and always gave a firm handshake. He asked thoughtful questions—“What’s your philosophy on this?”—but also seemed sure of himself. When job candidate Liane Wilson came to interview to become the head of Washington Mutual’s information technology department, Pepper told her that if she was selected for the job, he did not want her to use a new mortgage software program that had proved troublesome at other banks. Wilson was impressed not just that Pepper knew the details of the software program and that it hadn’t lived up to expectations elsewhere, but that he knew what he wanted. “It’s good to have strong leadership,” Wilson thought. “He’s not going to let you get away with a lot.” She took the job, despite her reservations about the bank’s financial position.
Bill Longbrake, meanwhile, lobbied to join Pepper as chief financial officer. After receiving Pepper’s call for help in 1981, he flew to Seattle from Washington, D.C., and stayed on at the bank for several days before returning to work. Now he wanted in, permanently. Pepper knew he needed Longbrake, who had a doctorate in finance. But Pepper worried about nepotism—Longbrake was married to Pepper’s niece. A board member eventually convinced him otherwise. “We can’t afford your scruples,” he admonished.
At about this time, a local investment banker called Pepper and encouraged him to hold a meeting with Murphey Favre, a securities brokerage in the eastern Washington city of Spokane. Pepper agreed. Kerry Killinger, one of the firm’s shareholders, arrived at Washington Mutual’s offices for the meeting. At thirty-one, Killinger looked barely old enough to roll a keg into a frat party. Pepper wasn’t intimidated by his age, except possibly as it related to competitive sports. “I know enough that if he played squash, I wouldn’t play him,” Pepper thought to himself. Inside Washington Mutual’s boardroom, Killinger told Pepper about Murphey Favre. The firm, as old as Washington Mutual, managed $400 million in assets across the “inland empire,” the eastern half of Washington State.11 The company ran top-performing mutual funds and offered customers financial advice. Washington Mutual, Killinger said, should consider a merger with the company. “You ought to buy us,” he told Pepper.
Pepper was suitably impressed. Killinger, he thought, was a young man trying to sell an old company and was doing a great job at it. But Pepper’s opinion of people selling securities wasn’t great. “They scare the hell out of me,” he said later. He thought many of them sold bad products for their own bottom line. Pepper didn’t like anything in banking that he considered “goofy.” Sometimes he would shoot down an idea from his team for that reason alone: “It’s goofy.” He believed in the adage “Never invest in a business you don’t understand.” Would Washington Mutual customers be safe investing in Murphey Favre’s securities? Pepper came to think so, as the management of the company approved everything it sold. Murphey Favre also offered tax-exempt bonds, a type of investment free of federal income tax. Washington Mutual customers clamored to buy them, and Pepper knew that.
Pepper agreed to the merger—with a catch. He wanted Killinger to work at Washington Mutual. Killinger agreed. One of the board members asked Pepper, “You know he probably wants to be CEO, right?” Pepper replied, “It doesn’t bother me.”
The executives whom Pepper assembled were as unusual as they were smart. Few had ever worked at a bank. Lindy Friedlander, the new head of Washington Mutual’s research department, held a PhD in biostatistics. Before she took the job, she had worked on a study for the University of Washington titled “Maximizing Compliance with Hemoccult Screening for Colon Cancer in Clinical Practice.” She was looking at how doctors could get patients to take, and return, home medical exams. While she had no experience in banking, she could find out anything about customers. One day Pepper asked her if she could create a statistical analysis of deposits by the color of a customer’s tie. “Yes,” she replied, seriously. “Don’t,” Pepper told her.
Pepper did not gauge people’s intelligence by their pedigree. Only a handful of people at Washington Mutual held advanced degrees. Some hadn’t even completed college. Pepper knew from experience that a degree can sometimes mean nothing at all. “There are a whole lot of people out there that aren’t getting the chance that they should,” he said later.
Several of the new executives came from small towns and had survived the same sort of gritty, rural childhood as Pepper. Fay Chapman, who took over for Pepper as the bank’s general counsel after he left, grew up in Gilroy, California, a dusty agricultural community that reeked of its chief export, garlic. Coworkers viewed Chapman as a sweet lady until she dropped the f-bomb in a meeting to make a point. “People don’t believe me, but as each of us turned eight, my grandfather gave us all guns,” said Chapman later.
They all dressed well, but not in the East Coast power-suit way. The men wore department store suits, and the women didn’t always wear makeup. The number of women in itself was startling. In addition to Chapman, Liane Wilson, Lindy Friedlander, and Lynn Ryder, a longtime Washington Mutual employee who headed up human resources, Pepper had also hired a twentysomething named Deanna Oppenheimer in marketing and Mary Pugh, who had just graduated with an economics degree from Yale, to deal with the hedging and other confusing investments. The number of women at the bank would have been unusual even today. Twenty-five years ago it sparked multiple newspaper articles. “The past decade certainly has seen an increasing number of women moving into executive positions in the business world,” noted the Puget Sound Business Journal of Washington Mutual’s new hires.
Other employees tended to find some of the people Pepper brought in eccentric, or at least nothing like the stereotypical stodgy banker. “Lou Pepper pulled together a group of misfits,” said one executive affectionately. Most of them would stay with the bank for the next decade or longer.
• • •
Employees at Washington Mutual grew used to Pepper’s somewhat unorthodox leadership style. He didn’t like to sit around, particularly not in his office. If he wanted to know what was happening at the bank, the last place he would find it, he reckoned, was staring out the window at Puget Sound. The other place he was sure wouldn’t provide him with answers about actual operations was a report. “He didn’t want to be fooled,” explained Chapman, who also didn’t care much for reports. “If you’re an exec, and you sit in your office and you ask someone below you for a report, what do you think it’s going to say? ‘Things are going great! When do I get my bonus?’” Instead, Pepper wandered the hallways, stopping in at various departments. He would plop himself down on someone’s desk, his leg hanging over the edge. “How are you doing?” he would ask. Or “I’m here to take your blood pressure,” he would joke. Others called it “management by walking around.” Executives felt comfortable wandering into Pepper’s office as well.
Pepper didn’t understand what “corporate culture” meant. He decided, “You shouldn’t act like a CEO, you should act like whoever the hell you are.” He encouraged executives to dress up on Halloween, bringing candy to the branches. He regularly ate in the cafeteria on the second floor with everyone else. He sat with the building’s maintenance men so frequently that they presented him with his own work jacket. To employees, he really seemed like one of them. He said things like “Jesus Peesus” and transitioned nearly every thought with “but anyhow.” “It was interesting times,” he said later, of his childhood. “But anyhow.” He often stitched together interesting anecdotes, or recited poetry, as a way of making an important point. This tic wasn’t always successful at Washington Mutual. Once Pepper tried to fire someone, but the employee left the room believing he had been given a promotion. Another executive had to relay the bad news.
His background, which employees heard in bits and pieces, helped endear him to people. Pepper had enlisted in the Army Air Corps during World War II and graduated from cadet school in the summer of 1944. The Army trained him and his buddies to fly two types of combat planes and then shipped them to Hawaii, where they waited to relieve another group in Okinawa. But soon afterward the war ended. Pepper never fought anyone, and that was fine with him. At least he had managed to secure a free college education, through the GI Bill. Pepper wasn’t sure what he wanted to do. He had previously enrolled in the University of Wisconsin as a science major. After the war, he opted for economics and then decided to get a law degree, too. “My dad had always admired lawyers,” he said. “He had been on a jury and thought lawyers were swell.” But when Pepper graduated at midyear, only one law firm in the state of Wisconsin had an opening for an associate. Someone else got the job.
• • •
Through the rain and the darkening evening, Pepper could see the rolling hills and the lights of the small downtown corridor as he drove into Seattle in December 1951. It looked huge to him. The Space Needle that would come to symbolize the city didn’t yet exist, and the tallest skyscraper was a spindly tower that would one day be dwarfed by a flurry of construction. Pepper had inherited the family car and saved some money from the war. After law school, he had applied for jobs in Washington, D.C., where one of his sisters lived, and in a couple of other cities, including Portland, Oregon, and Los Angeles. No one was hiring. He didn’t know anyone in Seattle but had stopped over there once during the war and liked how the city sat between lakes and the ocean, with a mountain range on either side. The managers of the dozen law firms he visited were nicer than those in other cities, but they had no jobs. Somehow he talked one of the local firms into hiring him temporarily. The firm needed someone to figure out if one of its clients, a national conservative talk show host, was about to get sued for libel. The firm’s partners kept giving Pepper more work, until finally he had a permanent job. Washington Mutual eventually became his largest client.
By 1986—five years into his unexpected run as chief executive—Pepper had saved Washington Mutual. The bank made nearly $71 million that year. Its stock soared to a high of more than $26 a share, allowing the bank to increase its cash dividend by 50 percent.12 One reason Washington Mutual was doing so well was that interest rates had dropped, luring customers to take out mortgages again. They arrived by the hundreds at Washington Mutual branches. The bank issued $467 million worth of mortgages that year, the highest volume it had ever produced, by far. While most customers still had a 30-year fixed-rate loan, adjustable-rate mortgages (ARMs) were becoming more popular. A typical ARM came with a fixed interest rate that automatically reset (usually higher) to the market rate after two or three years. Banks began making ARMs in the 1970s as another way to protect against interest rate swings. ARMs allowed banks to collect higher interest rate payments from some customers, offsetting the fixed rates paid by others. By the early 1990s, about 10 percent of homeowners held adjustable-rate mortgages, and customers were reporting problems. The banks were overcharging them in some cases. A federal government review reported that as many as 25 percent of the 12 million adjustable-rate mortgages in the United States in 1991 were “inaccurate.” “Adjustable-rate mortgages are extremely complicated,” warned a spokeswoman for the American Bankers Association at the time. “My advice to consumers is to take a close look.”
Washington Mutual introduced its own, borrower-friendly loan. The bank wouldn’t charge a customer more than a two-percentage-point increase when the loan adjusted. The bank also gave customers the unusual option of changing to a fixed-rate loan without going through the hassle of refinancing. “Is it good business practice to take advantage of the consumer’s gullibility and give them less than the best terms they qualify for?” Pepper wrote later, in a book describing his management philosophies. “My personal feeling is that you should always give them the best deal. I further think that if you do, you will make more money in the long run.”
• • •
With the bank no longer in any immediate danger, Pepper mulled over something less tangible: its culture. It was easy to offer someone a loan or a bank account, but couldn’t customers find that at a dozen other different banks? Also, why would a teller choose to work at Washington Mutual over any other bank? Prompted by an employee, he gathered a group of people from various departments and gave them a vague assignment: figure out Washington Mutual’s values. After a couple of months of deliberation, the committee reported back. The bank, its members decided, should focus on human value. Later, this included four areas: customers, coworkers, community, and the capital market (namely, shareholders). If any of those areas started to dictate the bank’s operations more than another, or if the bank overlooked one group, that would signal a problem. Washington Mutual would concentrate on five values: ethics (“All actions are guided by absolute honesty, integrity and fairness”), respect (“People are valued and appreciated for their contributions”), teamwork (“Cooperation, trust and shared objectives are vital to success”), innovation (“New ideas are encouraged and sound strategies implemented with enthusiasm”), and excellence (“High standards for service and performance are expected and rewarded”).
The exercise might have flopped, a victim of overzealous employee outreach. But perhaps because of Pepper, or maybe because he had pulled together a diverse group of people who weren’t involved in the company’s bureaucracy, Washington Mutual employees embraced the bank’s new creed. The executive team framed the values and hung them in bank branches. They were printed in annual reports. Managers received faux baseball cards with their picture and Washington Mutual’s logo on the front, and the values stamped on the back. The cards got traded back and forth. Working for the bank felt like being part of a very large, quirky family. Employees, with no irony, wore shirts that read “Washington Mutual cares about me.” For Pepper’s birthday in 1987, they dressed up, of their own accord, like the characters in The Wizard of Oz and performed an elaborate skit.
They called him down to the lobby of Washington Mutual’s headquarters and sat him down on a movable stage. With customers and intrigued tellers looking on, they pranced around wearing homemade costumes.
“I’m Glenda and I’m the WaMu witch,” proclaimed one employee wearing a long cream dress and a tiara.
“I’m Dorothy,” said another worker in a checkered dress and red high heels. “I’m a customer service representative and I’m looking for some enchantment in the way I deal with my customers.” The idea of enchantment became a big deal at Washington Mutual after Pepper gave a speech instructing employees to think beyond products and services. “Let us be sure we leave room for an enchantment, a challenge, an experimentation—fun, far out, exciting things that may one day be our own mystique, our own mark—that sets us so far above the crowd that we won’t be able to see it. Not only will we succeed financially, we will succeed as human beings,” he said.
“You’ll want to go to the land of corporate values!” announced the WaMu witch.
“Oh, where’s that?” replied Dorothy as a larger crowd gathered in the bank’s lobby.
“All you have to do is follow the WaMu road. When you reach the land of corporate values, go and see the great and powerful Lou!”
The skit, which involved Dorothy skipping circles around Pepper as the song “Louie, Louie” played, ended with everyone donning cutout paper masks of Pepper. Pepper, exceedingly entertained, received a new stamp with the acronym “G.P.L.” Great and Powerful Lou. Long after Pepper retired, it became far more common to run into someone who had worked at the company for 15 years rather than 5. Few people wanted to leave.
Employees weren’t the only ones in love with Washington Mutual. The bank had rehabilitated an old advertisement launched sometime in the 1970s proclaiming Washington Mutual the “Friend of the Family.” The company hired an older, avuncular actor and dressed him up in Mr. Rogers–style cardigans. He became the face of Washington Mutual, assuring customers that the bank would take care of them. “Washington Mutual has always been a family bank,” said the actor in one commercial, as a family smiled and passed around dinner plates. “We like to think of ourselves as specialists in family banking, from the smallest savings account up. Washington Mutual. Friend of the Family.” Customers brought the bank more money.* Pepper could tell that the bank was growing. He spent a day sitting in the Washington Mutual branch near his house. He sat in the corner of the branch for a long time, and none of the customers recognized him or came over to greet him. They were all new customers.
By 1986, Pepper faced another problem, though: his succession. In three years, he would turn sixty-five. He had told the board, and promised himself, that he wouldn’t stay on past retirement age. He figured he had two options: sell Washington Mutual, or find someone to take his place. While selling the bank wasn’t ideal, it would have been a good time. Washington Mutual sat in a relatively strong position, even though another banking crisis was unfolding around it. This time banks were failing by the hundreds because of an energy downturn in oil states like Texas and Oklahoma, a commercial real estate bust in California and the Northeast, and an agricultural recession rippling through the midwestern states. In each region, banks had made loans that soured because of their region’s respective downturn. Bank failures would surge to more than 1,000 during the Savings and Loan Crisis, the highest number since Pepper’s sister saw her college funds evaporate.
One of the banks that failed early on was Continental Illinois National Bank and Trust Co., the largest financial institution in Chicago and one of the ten largest nationwide. “The Continental” had grown in the 1970s after its management team set an ambitious goal: to become one of the largest commercial real estate lenders in the United States. In just a few years, the bank increased its assets by more than 100 percent to $45 billion. Its stock price more than tripled, surging to $40 a share in 1981. Analysts, investors, and journalists heralded the management team and the bank’s strategy.13 One Salomon Brothers analyst described Continental as “one of the finest money-center banks going.”
But the rapid growth led to problems. Continental had lent heavily to energy-related companies and charged much lower interest rates to entice businesses to take out loans. But when oil prices dropped, some of Continental’s biggest clients started losing money, and thus Continental started losing money as well. When Penn Square, a huge bank in Oklahoma, failed, news spread that Continental was involved by as much as $1 billion with some of the speculative energy lending of Penn Square. The rating agencies downgraded Continental, one of the first signs of serious trouble. One reporter noted that the only difference between Continental and the Titanic was that the Titanic had had a band.
After Reuters ran a story suggesting Continental would file for bankruptcy, the bank’s customers began withdrawing their money. Other banks stepped up with a $4.5 billion bailout package to help Continental, fearful of what its failure could mean to the industry. The money wasn’t enough. The federal government had to decide: Was Continental too big to fail? It was the first time the description arose. (An acronym was born: TBTF.) If too many other financial institutions and companies were tied up with it, the bank’s failure could spark an even bigger crisis. The government looked for another company to buy Continental but couldn’t find one. Finally, it cobbled together a bailout package that included buying some of the bank’s $400 million in bad loans and propping it up with capital. The government now owned 80 percent of the bank, a controversial move that sparked cries of socialism. At that point, Continental’s 1984 downfall marked the largest bank failure in U.S. history.
Pepper had steered Washington Mutual away from these problems, refusing to listen to the siren call of analysts or shareholders. The analysts thought everyone should make more commercial real estate loans. Instead, Pepper started shrinking Washington Mutual’s portfolio of them. He got out of one relationship with a broker in California who was funneling over commercial real estate loans. “Things began to get goofy” out in California, he said later. At one shareholder meeting, an investor stood up and demanded to know why Pepper wasn’t as smart as the chief executive of another bank in Seattle, which was making more money. “We’re doing what we think is right,” Pepper responded. “Shareholders can put their money wherever they want.” By the next year, the bank in question had failed. At Washington Mutual’s shareholder meeting, Pepper couldn’t resist pointing that out.
To avoid commercial real estate lending—one of the biggest problems of the day—Pepper hired Craig Tall. Tall, who is actually relatively short, had never worked at a bank and had been brought in to sort out retirement planning. But Tall was, at heart, an entrepreneur. He convinced Pepper and the board to let him make some unusual acquisitions to bring in more money from other lines of business, including a travel agency. For several years, Washington Mutual customers could deposit money at a branch and then book a trip to Kauai at Mutual Travel. The ventures, to the surprise of some, made money.
Pepper decided to explore a sale of Washington Mutual, a possibility he had considered over the years. The only real candidate emerged in Minneapolis at Norwest, another savings and loan bank. But Norwest’s eventual offer came in too low, and the deal fell apart. Next, Pepper hired a search firm to find a new president. He found one person whom he liked on the East Coast, but it was hard to persuade him to leave the financial power centers for a city known more for its growing fish and farmers’ market than for its banks. Also, Pepper didn’t really think that any of the people whom the search firm turned up were better than the executives he had already hired.
One day he called his senior managers into a conference room and told them that he had decided to create an “Office of the President.” He would remain chief executive, chairman, and president, and he appointed not one, but two senior executives to assist him: Bill Longbrake and Kerry Killinger. The two men would split the duties of managing Washington Mutual, Pepper told the team. Other executives would report to one or the other. In any other company, the unusual move might have come with the high risk of creating fracture and sparking a backstabbing race for the president’s position between Longbrake and Killinger.
But Pepper, although he favors long stories, is also direct. He never shied away from problems at the bank. He warned the management team, as they sat in the conference room, that he would tolerate no politics. “If any of you starts playing favorites, you’ll be out of here, forthwith,” he warned. “This is a cooperative effort, not a competition.” The team followed orders. This unusual arrangement lasted for more than a year, until Pepper chose Killinger as president. The decision surprised Longbrake. He knew Pepper would retire one day, but he had believed that the bank would be run jointly. He believed his strengths would complement Killinger’s. While both men possessed an exceptional ability to digest complicated financial reports, Longbrake—who comes from a family of Presbyterian ministers and is a talented piano player—believed he could run internal operations better. More worrisome for Longbrake was that Killinger, who had spent his career as a money manager, tended toward the risky side. He thought about Killinger’s recent foray into junk bonds. Other troubled savings and loan banks had started issuing debt to raise money. The bonds came with a high interest rate because they weren’t rated very high. One of them came from Centrust, a savings and loan bank in Florida (whose chairman would later be famously convicted of fraud). The banks were in trouble and the risk of default was high. The banks started closing. Pushed by national financial reform, the market collapsed. Washington Mutual had to set aside $14 million to cover the losses on the bonds, more than three times the amount of the previous year.14 Earnings suffered.
When Killinger brought up the idea of investing in junk bonds, Pepper had seen it as a creative, relatively safe way to raise more money. He appreciated Killinger’s looking for ways to expand the business. Both executives failed to anticipate the rapid downturn of the market. They had no way of knowing that the government would pass new legislation that would render those investments worthless. “They were not the best thing we’d ever done,” Pepper said later. “But it wasn’t the worst thing either.” Longbrake, incidentally, was charged with cleaning up the bond mess, which he eventually sorted out.
In Killinger, Pepper saw potential but not perfection. He viewed himself the same way. Pepper was wooed by Killinger’s intelligence. Executives and board members quickly realized that if you handed Killinger a report on any subject, or tried to explain something that you found to be confusing, he understood it almost immediately and sometimes better than you did. On the off chance that he didn’t, he would ask half a dozen smart questions and then would understand. He had an uncanny instinct for spotting good companies. The mutual funds he had run at Murphey Favre always performed in the top percentile.
Killinger possessed an unflagging energy. His love of Washington Mutual seemed to parallel Pepper’s. He often left home at 6:00 a.m., not returning until well after dinnertime. During lunch he ate a sandwich at his desk, instead of heading down to the second-floor cafeteria, which served casseroles and roast beef. One manager recalled that on several occasions, he shut the door of his office and ran rapidly in place or did push-ups. His two sons, Bryan and Brad, and his wife of twenty years, Debbie, got used to Killinger’s absence. His sons often teased him that they planned to open an account at Bank of America or another competitor.
What Killinger didn’t have a lot of, but Pepper thought he could develop, was charisma. Killinger was, at heart, an analyst, more comfortable with numbers than with people. He wore glasses that covered his face. His short brown hair was swept to one side in a comb-over. He was friendly and polite. He had a perplexing habit of never looking directly at you; his brown eyes would focus instead on the wall in the distance or the desk to the left. While Pepper would talk to anyone, an employee who stood alone with Killinger in an elevator sometimes suffered an awkward silence. Once, at a luncheon awards ceremony, Killinger sat a table with several Washington Mutual tellers and lower-level employees who were going to be honored. All the employees were nervous about Killinger’s presence, so none of them spoke. Killinger didn’t either. He focused on his food. Finally, one of the employees, who was taking a class to learn more about banking, broke the silence. “Where do you see the industry going in the next five years?” she asked him. Killinger’s demeanor instantly changed. For the rest of the lunch hour, he rattled off his predictions. “We had the best discussion,” the employee later recalled. She scribbled notes on napkins and later received a high grade on a paper she wrote on the subject. Pepper, meanwhile, had gotten both Killinger and Longbrake subscriptions to The Atlantic Monthly after appointing them dual presidents. He hoped that the narrative essays and fictional stories would offset all the financial reports they read.
Killinger had several other management flaws that worried Pepper somewhat, but he trusted the other executives he had appointed to make up for them. He hoped that after he himself left, they would serve as something of a life raft around Killinger. For one thing, Killinger was not particularly deft at reading people. He had called Chapman at the bank’s outside law firm one day and asked her to come in for a meeting. Puzzled by the unscheduled request, she walked the short distance to the bank and showed up at Killinger’s office. “I have a couple of real blind spots, particularly when it comes to some employees,” he told Chapman. In not so many words, he was asking Chapman to watch his back. If a manager was taking advantage of him, or was out of line and he wasn’t seeing it, would she please tell him? Chapman agreed and kept that promise for almost two decades. Killinger also delegated the role of assessing other people to his wife. He sometimes brought Debbie along to meet a competing chief executive or potential hire, just to get her opinion on the person.
• • •
On a snowy day in December 1988, the board of Washington Mutual appointed Killinger president. A year later he became chief executive and, several months after that, chairman of the board. Pepper kept a position on the board and an office at the bank, but he and Mollie left for a vacation on the Greek Islands after Killinger took over as chief executive. Pepper called his secretary once to ask how things were going. “Good,” she replied, and then there was silence. “Well, what’s going on?” Pepper asked. “Oh, lots of things.” She paused again. Pepper caught on. “You don’t need me anymore, do you?” he concluded.
Before he left, Pepper found an old certificate of deposit with a rate of 16.5 percent stamped on it. “Sixteen point five percent!” thought Pepper. The ridiculously high interest paid on the CD was a vestige of his first few years at Washington Mutual, when the bank had come close to failure. Now Washington Mutual ranked as one of the strongest banks in the Pacific Northwest, even during the Savings and Loan Crisis. Not only was it profitable, but it had grown from $2 billion in assets to $7 billion during the nine years of Pepper’s tenure, and added fifteen branches.
Pepper framed the faded CD. Then he had a plaque made. He presented both to his new chief executive. The plaque read: “Whenever new troops arrived anywhere during World War II, the old troops greeted them by saying: ‘You should have been here when it was really rough.’”15 Always the jokester, Pepper wanted to remind Killinger that his job would be easy compared with the struggle that Pepper endured. It couldn’t possibly get any worse.
What People are Saying About This
"An eye-opening book."—Booklist
Meet the Author
Kirsten Grind has received more than a dozen national awards for her work, including a Pulitzer Prize finalist citation. A reporter for The Wall Street Journal, she lives in New York City.
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We received a brand new copy of the book the same week we placed the order without using expedited shipping. The book was cheaper than any new or used copy I could fine on-line. I definitely plan to use B&N again.
As a shareholder, I never had a secure feeling concerning Washington Mutual. Too many friends owned the stock too and few understood how their earnings could be so huge, given most of their business was creating mortgages. Then came the option ARM and I elected to sell my interest. This is a thoroughly interesting saga of a good business turned bad. Kirsten Grind presents a first rate accounting of WaMu's demise. I finished it, totally entertained, but shaking my head. Great book!
An interesting, well-written book, but it reads like an extended collection of the authors WSJ coverage on the same topic... a lot of who what where and when, very little why or what does it all mean. In short, there was a little S&L called Washington Mutual, they grew to monster size writing a lot of bad mortgages to people who really couldn't afford them, their greediness finally caught up with them and the bank collasped. The end. There's not much more to it than that.