WaMus pay system rewarded loan officers for the volume and speed of the subprime mortgage loans they closed on. Extra bonuses even went to loan officers who overcharged borrowers on their loans or levied stiff penalties for prepayment, according to the report being released by the investigative panel of the Senate Homeland Security and Governmental Affairs Committee.

Testifying at a hearing of the subcommittee Tuesday are former Washington Mutual CEO Kerry Killinger, ex-President and Chief Operating Officer Stephen Rotella, and David Schneider, who was the highest-ranking executive in the banks home lending operation. Two former chief risk officers and an internal auditor are also due to appear.

Sen. Carl Levin, D-Mich., the subcommittee chairman, said Monday the panel wont decide until after the hearings on Tuesday and Friday whether to make a formal referral to the Justice Department for possible criminal prosecution. Justice, the FBI and the Securities and Exchange Commission opened investigations into Washington Mutual soon after its collapse in the fall of 2008 at the height of the financial crisis.

The new report by the Senate investigators said the top WaMu producers, loan officers and sales executives who made high-risk loans or packaged them into securities for sale to Wall Street, were eligible for the banks Presidents Club, with trips to swank resorts - like Maui in 2005.

Fueled by the housing boom, Seattle-based Washington Mutuals sales to investors of packaged subprime mortgage securities leapt from $2.5 billion in 2000 to $29 billion in 2006. The 119-year-old thrift, with $307 billion in assets, failed in September 2008. It was sold for $1.9 billion to JPMorgan Chase & Co. in a deal brokered by the Federal Deposit Insurance Corp.

WaMu was one of the biggest makers of so-called “option ARM” mortgages, which allowed borrowers to make payments so low that loan debt actually increased every month.

The Senate subcommittee investigated the Washington Mutual failure for a year and a half. It focused on the thrift as a case study for the financial crisis that brought the recession and the loss of jobs or homes for millions of Americans.

Senior executives of the bank were aware of the prevalence of fraud, the Senate investigators found.

Washington Mutual “was one of the worst,” Levin told reporters Monday. “This was a Main Street bank that got taken in by these Wall Street profits that were offered to it.”

The investors who bought the mortgage securities from Washington Mutual werent informed of the fraudulent practices, the Senate investigators found. WaMu “dumped the polluted water” of toxic mortgage securities into the stream of the U.S. financial system, Levin said.

In some cases, sales associates in WaMu offices in California fabricated loan documents, cutting and pasting false names on borrowers bank statements. The companys own probe in 2005, three years before the bank collapsed, found that two top producing offices - in Downey and Montebello, Calif. - had levels of fraud exceeding 58 percent and 83 percent of the loans. Employees violated the banks policies on verifying borrowers qualifications and reviewing loans.

Washington Mutual was repeatedly criticized over the years by its internal auditors and federal regulators for sloppy lending that resulted in high default rates by borrowers, according to the report. Violations were so serious that in 2007, Washington Mutual closed its big affiliate Long Beach Mortgage Co. as a separate entity and took over its subprime lending operations.

In late 2006, Washington Mutuals primary regulator, the U.S. Office of Thrift Supervision, allowed the bank an additional year to comply with new, stricter guidelines for issuing subprime loans.

According to an internal bank e-mail cited in the report, Washington Mutual would have lost about a third of the volume of its subprime loans if it applied the stricter requirements.

Jennifer Zuccarelli, a spokeswoman for JPMorgan Chase, declined to comment Monday on the subcommittee report.

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But it depends on cooperation from investors and bankers, many of whom have been locked in disputes over whether to reduce the debt owed by homeowners.

And just like the bank bailouts, this rescue plan poses risks. If it doesnt slow the wave of foreclosures or if home prices nosedive, the tentative recovery in the housing market could fizzle.

The Obama administration says the plan will help stabilize the real estate market by keeping many borrowers out of foreclosure. If it succeeds, the plan would limit damage to the overall economy.

The new effort is designed to help two groups:

- Borrowers who owe more on their loans than their houses are worth. More than 15 million homeowners fall into this category, according to Moodys Analytics. About 10 million of them owe at least 20 percent more than their houses current value.

Their mortgage companies can cut the total amount they owe, or they can refinance into loans backed by the Federal Housing Administration. FHA will get $14 billion in incentive money from the federal bailout fund.

- Unemployed borrowers. People receiving unemployment benefits would have their mortgage payments cut to no more than 31 percent of their monthly income for three to six months.

Thats intended to give homeowners more time to find a job. Once they do, they may qualify for a loan modification that would permanently reduce their payments under the administrations existing $75 billion loan modification program.

The plan aims to help 3 to 4 million borrowers avoid foreclosure - the same target the administration tried to reach with its original plan last year. Even with the changes, the effort will likely prevent no more than 1.5 million foreclosures, estimates Mark Zandi, chief economist at Moodys Analytics.

Disputes among banks and investors, who would have to approve any cuts in loan principal, could prevent the effort from stopping more foreclosures, as could another drop in home prices.

“Practically speaking, this is probably going to prevent foreclosures. But I dont think theyre ever going to reach 3 to 4 million homeowners,” said Chris Mayer, a real estate professor at New Yorks Columbia Business School. “These plans always turn out to be harder than we think.”

Still, analysts said this effort has a better chance of success than past efforts because it would reduce principal for some struggling borrowers - a method more effective at helping homeowners than reducing interest payments or other forms of aid. Laurie Goodman, a widely followed mortgage securities analyst with Amherst Securities Group, called it “a huge step forward.”

The plan comes after pressure from the administrations Democratic allies in Congress to intensify efforts to help Americans at risk of losing their homes.

The overhauled plan came together after several months of negotiations between the Treasury Department, major banks and investors in mortgage securities. A major sticking point so far has been getting everyone involved to agree on restructuring loans.

The problem is that most of the troubled mortgages arent owned by the banks themselves. They were bundled into securities during the housing boom and sold to investors.

To reduce principal payments on those mortgages, banks often must get permission from the investors who hold the securities - and may not be willing to take less.

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The House passed the measure 220-207 as part of an expedited bill that also fixed provisions in the new health care law. Earlier Thursday, the Senate passed the bill 56-43.

The switch to direct government loans will result in savings to boost Pell Grants and make it easier for some workers to repay their student loans. In addition, some borrowers could see lower interest rates and higher approval rates on student loans.

The legislation has a wide reach. About half of undergraduates receive federal student aid and about 8.5 million students are going to college with the help of Pell Grants.

Sen. Tom Harkin, D-Iowa, praised the bill as a victory for middle-class families.

“Now theyll have the assurance that their kids will be able to afford to go to college and again, when they get out, they wont be burdened with a huge debt,” Harkin said.

The changes do not go as far as Obama and House Democrats wanted. That is because ending fees for private lenders would save less money than they anticipated, according to budget scorekeepers. The bill is now expected to save $61 billion over 10 years.

As a result, the Pell Grant increase is modest and still doesnt keep up with rising tuition costs. Advocates had sought bigger increases.

“The increases in the Pell Grant are better than nothing, but they are still quite anemic,” said analyst Mark Kantrowitz, publisher of the student assistance Web site FinAid.org.

When Pell Grants were created in 1972, the maximum grant covered nearly three-quarters of the average cost of attending a public four-year college. In 2008, the latest year for which figures are available, the maximum grant covered about a third of the cost. And debt affects the careers graduates choose.

“Were seeing students being squeezed out of socially valuable jobs like teaching and social work” because of their debts, said Rich Williams, who has worked on the bill for the Public Interest Research Group, a consumer advocacy organization.

Private lenders still will make student loans that are not backed by the government, and they still will have contracts to service some federal loans. But the change represents a significant loss to what has been a $70 billion business for the industry.

-Pell Grants would rise from $5,550 for the coming school year to $5,975 by 2017. Lawmakers had initially hoped to reach a $6,900 cap.

-More eligible students could get a full Pell Grant. Most grants go to students with family income below $20,000, but students with family income of up to $50,000 may also be eligible.

-Some college graduates will have an easier time repaying loans. The government will essentially guarantee that workers in low-paying jobs will be able to reduce their payments. Current law caps monthly payments at 15 percent of these workers incomes; the new law will lower the cap to 10 percent.

Savings from the measure will also go toward reducing the deficit and helping to pay for expanded health care.

The loan program caused a hitch in Democrats plan to send the health care fixes promptly to President Obama.

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For the full year, Northern Rock reported a pretax loss of 257.5 million pounds ($384 million), down from a loss of 1.355 billion pounds in the previous year.

Loan loss impairments rose to 1.05 billion pounds from 894 million pounds in 2008.

“Loan loss impairment charges are expected to remain high during 2010, relative to historic norms, but below the level recorded in 2009,” the company said.

The results were the last for the old company, which on Jan. 1 was split into two units.

Northern Rock PLC, which expects to return to profit, holds 10 billion pounds in mortgages, 5 billion pounds cash, 5 billion pounds of the government loan to Northern Rock and 19 billion pounds in retail deposits.

The second unit, Northern Rock (Asset Management) PLC, holds 80 billion pounds of Northern Rocks riskiest assets, the rest of the residential mortgage book, the bulk of the existing government loan to Northern Rock plus the banks wholesale funding instruments. It will not accept deposits and will not issue new mortgage loans.

During 2009, Northern Rock increased gross residential lending to 4.2 billion pounds, up from 2.9 billion pounds in 2008.

Northern Rock said it would pay 13.4 million pounds to managers who met their targets, plus 1.5 million pounds in extra taxes on bonuses, but Chief Executive Gary Hoffman waived his entitlement for the year.

Northern Rock, once the countrys fifth biggest lender, suffered the first run on a British bank since 1866 after the Bank of England announced in September 2007 that it had provided emergency funding.

The government pumped 27 billion pounds in loans and assumed contingent liabilities of 29 billion pounds in an effort to keep Northern Rock afloat, before resorting to nationalization on Feb. 22, 2008.

The government gauranteed 100 percent of customers deposits in Northern Rock, and that guarantee remains in place.

Since Northern Rock was taken over, the government also took control of mortgage lender Bradford & Bingley, an 84 percent stake in Royal Bank of Scotland and a 43 percent stake in Lloyds Banking Group.

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On the Net: http://www.northernrock.co.uk/

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“The level of distress continues to rise irrespective of improving economic trends,” Sam Chandan, Real Capitals global chief economist, said in a telephone interview.

The U.S. jobless rate declined to 9.7 percent in January from 10 percent in December, after hitting a 26-year high of 10.1 percent in October. Unemployment and tighter credit are hurting commercial property values, which fell 29 percent in December from a year earlier and are down 41 percent from the October 2007 peak, according to the Moodys/REAL Commercial Property Price Index released Feb. 22.

U.S. banks with $100 million to $1 billion in assets hold 25 percent of commercial property loans outstanding and 15 percent of apartment loans, Real Capital data show. The biggest banks, those with more than $10 billion in assets, hold about half of commercial loans and two-thirds of apartment loans.

“With the concentration of commercial mortgages in small and community banks, there is a potential spillover that will impinge on their ability to make loans to small businesses and families,” Chandan said.

Almost $1.1 trillion in commercial loans and $211 billion in apartment loans were held by U.S. banks on Dec. 31, according to Real Capital.

Smaller Banks

The Congressional Oversight Panel on the financial system bailouts said in a Feb. 10 report that “the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks” that have higher concentrations of such loans.

“Some community banks seemed to have abandoned, or never really practiced, sound risk management” by lending too much on real estate in their local markets, David A. Hendler, New York- based analyst for CreditSights Inc., said in a Feb. 22 note.

The commercial default rate rose from 3.4 percent in the third quarter, representing an increase of $4.5 billion in defaulted loans in the period, according to Real Capital. The rate will reach 5.1 percent at the end of this year, the research firm said.

The apartment default rate rose from 3.6 percent in the third quarter. The jump reflected a $1.6 billion increase in defaulted loans. Apartment defaults will peak at 5.3 percent at the end of 2010, said Real Capital, which based its analysis on bank filings and data from the Federal Deposit Insurance Corp.

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Now, the days of tapping your house for easy money have gone the way of soaring home prices. A quarter of all homeowners are ineligible for home equity loans because they owe more on their mortgage than what the house is worth. Those who have equity in their homes are finding banks far more stingy. Many with home-equity loans are seeing their credit limits reduced dramatically.

The sharp pullback is dragging on the economy, household budgets and banks books. And its another sign that the consumer spending binge that powered the economy through most of the decade is unlikely to return anytime soon.

At the peak of the housing boom in 2006, banks made $430 billion in home equity loans and lines of credit, according to the trade publication Inside Mortgage Finance. From 2002 to 2006, such lending was equal to 2.8 percent of the nations economic activity, according to a study by finance professors Atif Mian and Amir Sufi of the University of Chicago.

For the first nine months of 2009, only $40 billion in new home equity loans were made. The impact on the economy: close to zero.

“The home as ATM is yesterday,” says Keith Gumbinger, vice president of HSH Associates Financial Publishers, which publishes consumer loan information.

Millions of homeowners borrowed from the house to improve their standard of living. Now, unable to count on rising home values to absorb more borrowing, indebted homeowners are feeling anything but wealthy.

Holly Scribner, 34, and her husband took out a $20,000 home equity loan in mid-2007 - just as the housing market began its swoon. They used the money to replace sinks and faucets, paint, buy a snow blower and make other improvements to their home in Nashua, N.H.

The $200 monthly payment was easy until property taxes jumped $200 a month, the basement flooded (causing $20,000 in damage) and the family ran into other financial difficulties as the recession took hold. Their homes value fell from $279,000 to $180,000. They could no longer afford to make payments on either their first $200,000 mortgage or the home equity loan.

Scribner, who is a stay-at-home mom with three children, avoided foreclosure by striking a deal with the first mortgage lender, HSBC, which agreed to modify their loan and reduce payments from $1,900 a month to $1,100 a month. The home equity lender, Ditech, refused to negotiate. Scribners husband, Scott, works at an auto loan financing company but is looking for a second job to supplement the familys income.

The family is still having trouble making regular payments on the home-equity loan. The latest was for $100 in November.

“It was a huge mess. I ruined my credit,” Holly Scribner says. “We did everything right, we thought, and we ended up in a bad situation.”

Home equity lending gained popularity after 1986, the year Congress eliminated the tax deduction for interest on credit card debt but preserved deductions on interest for home equity loans and lines of credit. Homeowners realized it was easier or cheaper to tap their home equity for cash than to use money taken from savings accounts, mutual funds or personal loans to fund home improvements.

Banks made plenty of money issuing these loans. Home equity borrowers pay many of the costs associated with buying a home. They also may have to pay annual membership fees, account maintenance fees and transaction fees each time a credit line is tapped.

In 1990, the overall outstanding balance on home equity loans was $215 billion. In 2007, it peaked at $1.13 trillion. For the first nine months of 2009, its at $1.05 trillion, the Federal Reserve said. Today, there are more than 20 million outstanding home equity loans and lines of credit, according to First American CoreLogic.

But delinquencies are rising, hitting record highs in the second quarter. About 4 percent of home equity loans were delinquent, and nearly 2 percent of credit lines were 30 days or more overdue, according to the most recent data available from the American Bankers Association.

A rise in home-equity defaults can be particularly painful for a bank. Thats because the primary mortgage lender is first in line to get repaid after the home is sold through foreclosure. Often, the home-equity lender is left with little or nothing.

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The reason is simple - a recognition that Japans famously high suicide rate is not so much a feature of Japanese culture, drawing from samurai or kamikaze traditions, but is uniquely woven into the health of the economy.

So instead of treating the suicidal just for depression, as has long been the practice, the city offers financial and legal counseling, along with “hope loans” - or “nozomi” loans in Japanese - to get the needy out of debt.

The suicide rate in Kurihara fell from 48.6 per 100,000 people in 2005 to 27.5 in 2007, and city officials expect it to decline again this year, even as the rate rises nationwide.

Now other municipal governments are looking to this city of 80,000 for inspiration.

Makoto Ishikawa believes his life was saved by a nozomi loan.

The 47-year-old has an office job and also runs a family rice farm. Last year, he began drowning in debt to pay his two childrens college fees and buy new farm equipment.

“So many bills began piling up,” he said. “I realized I needed help.”

His plight sounds much like that of millions worldwide in these tough times, but Japan is different. Here banks set stringent conditions for loans, forcing borrowers to rope relatives and friends into guaranteeing repayment.

This can plunge a defaulter into extreme guilt and despair, says Yasuyuki Sawada, lead researcher on a study published last year by University of Tokyo that showed a particularly high correlation between the suicide rate and economic indicators such as gross domestic product.

Yasuyuki Shimizu, a leading anti-suicide campaigner, says: “Japan is a society in which the weak are beaten down, and they are beaten down more quickly than other places. Japan is not an easy place to live.”

Japans economy has languished since its economic heyday in the 1980s, but the high suicide rate tended to be associated, particularly by foreigners, with the samurai ritual of hara-kiri (self-disembowelment) or with the kamikaze pilots of World War II.

“But its not true. People are driven to suicide because they are struggling in their daily lives. And Id like people to know that even a little city in rural Japan can take steps to effectively tackle the problem.”

The mayor commissioned a survey of 500 residents which found a high number of middle-aged, self-employed men who had contemplated suicide because of financial strains.

Ishikawa, partly self-employed, was typical of the hard-luck cases in this city of rice farms, cattle ranches and hot springs. But rather than abandon hope, he went to the local bank, which referred him to city hall.

The city assigned him a case worker, who got him legal advice and eventually a 10-year personal loan of 8.2 million yen ($93,000), at 7.9 percent interest, which he used to consolidate his debt.

A similar loan from a consumer credit company would have charged double the interest. The nozomi loan still requires a guarantor, but he or she can be an immediate family member, such as a spouse, with the idea that the couple would work together to pay off the loan.

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The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt. While new sales would signal Wall Streets return to investments that contributed to $1.7 trillion of writedowns and credit losses worldwide, they may help companies refinance $1.5 trillion of high-yield loans and bonds maturing by the end of 2014.

“Market conditions have improved dramatically over the course of this year, which we see carrying on into 2010,” said Philippe Roger, JPMorgans global head of structured credit trading. “We are actively discussing the market environment with our clients, and think that they are going to be increasingly attracted both to the leveraged-loan asset class and securitization technology and applications related to the high-yield space.”

Less Volatile

Roger, who is based in London, declined to comment on specific dialogue the firm has had in creating CLOs.

Frankfurt-based Deutsche Bank AG, Germanys biggest bank, is also considering creating CLOs with loan managers, said the people, all of whom had direct talks with the banks. Spokeswomen for Citigroup of New York, Deutsche Bank and Charlotte, North Carolina-based Bank of America declined to comment.

JPMorgan Chase, Bank of America and Citigroup are the three largest U.S. banks as ranked by assets, according to data compiled by Bloomberg.

Leveraged loans have returned a record 49.3 percent this year after losing an unprecedented 28.2 percent in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poors/LSTA U.S. Leveraged Loan 100 Index. Leveraged loans are rated below BBB- by S&P and less than Baa3 at Moodys Investors Service.

New issues of CLOs may reach $3 billion to $6 billion next year, Wells Fargo Securities LLC senior analyst Dave Preston in Charlotte, North Carolina, wrote in a report yesterday.

CLO Sales Swelled

For banks to be able to create new CLOs, leveraged-loan prices need to be less volatile and financing costs for the top- rated portions must be lower, said David Yan, a Credit Suisse Group AG analyst in New York, who predicts issuance may return in the first quarter of 2010.

The increase enabled CLOs to finance almost two-thirds of the loans that backed the record $616 billion of leveraged buyouts in the first half of 2007, Standard & Poors LCD data show.

Demand for loans began to slow in July 2007, when bankers couldnt find investors for the credit they provided to New York-based KKR & Co.s 11.1 billion-pound ($18.1 billion) purchase of British drugstore chain Alliance Boots Ltd.

Stress Scenarios

By April 2009, amid the worst financial crisis since the Great Depression, the slices of CLOs with BBB ratings plummeted to 6 cents on the dollar, while the safest portions fell to 69 cents, Morgan Stanley data show.

As the U.S. has lent, spent or guaranteed $11.6 trillion to rescue the financial system and pull the economy out of recession, prices on the S&P/LSTA loan index rose to 86.31 cents on the dollar from the record low in December 2008 of 59.2 cents.

Banks need to make “an extraordinary commitment” to help rebuild the economy, President Barack Obama said yesterday, after the government bailed them out of a crisis “largely of their own making.”

Even as bond issuance soared this year as borrowers took advantage of record-low interest rates and investor demand for higher-yielding assets, sales of leveraged loans to high-yield, high-risk companies has declined 45 percent from the same period in 2008.

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“We are taking additional steps to enhance servicer transparency and accountability,” Reilly said. She said the goal was to increase the rate that troubled home loans were converted into new loans with lower monthly payments.

Industry officials said the new effort would include increased pressure on mortgage companies to accelerate loan modifications by highlighting firms that are lagging in that area.

The Treasury is also expected to announce that it will wait until the loan modifications are permanent before paying cash incentives to mortgage companies that lower loan payments.

Under the $75 billion Treasury program, companies that agree to lower payments for troubled borrowers collect $1,000 initially from the government for each loan, followed by $1,000 annually for up to three years.

The government support, which is provided from the $700 billion financial bailout program, is aimed at providing cash incentives for mortgage providers to accept smaller mortgage payments rather than foreclosing on homes.

The program has come under heavy criticism for failing to do enough to attack a tidal wave of foreclosures. Analysts said the foreclosure crisis is likely to persist well into next year as high unemployment pushes more people out of their homes.

Rising foreclosures depress home prices and threaten the sustainability of the fledgling economic recovery.

A report last week from the Mortgage Bankers Association found that 14 percent of homeowners with mortgages were either behind on payments or in foreclosure at the end of September, a record level for the ninth straight quarter.

The Congressional Oversight Panel, a committee that monitors spending under Treasurys bailout program, concluded in a report last month that foreclosures are now threatening families who took out conventional, fixed-rate mortgages and put down payments of 10 to 20 percent on homes that would have been within their means in a normal market.

Treasurys program, known as the Home Affordable Modification Program, “is targeted at the housing crisis as it existed six months ago, rather than as it exists right now,” the report said.

Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, said the industry supported many of the changes Treasury was proposing.

“The subprime problem has regrettably morphed into an unemployment problem,” Talbott said. He said there was no government program to help the unemployed who are in danger of losing their homes but “many private lenders are modifying loans for the unemployed on their own.”

Treasurys Reilly said the expanded program would, among other steps, make more aid available to struggling borrowers and expand the number of organizations providing help.

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Associated Press writer Jim Kuhnhenn contributed to this report.

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His comments come days after the agency revealed its financial reserves have fallen to a dangerously low level due to more homeowners defaulting on their loans. The FHA does not make loans, but rather offers insurance against default.

Thats led to mounting concerns that it will eventually need an infusion of cash like government-controlled mortgage finance companies Freddie Mac and Fannie Mae.

But Stevens sought to dampen those concerns, noting that despite the most severe housing recession in decades, the agency has $31 billion in capital - $3.5 billion more than it had a year ago.

FHA is “the only participant in home financing services in the U.S. economy that hasnt needed a bailout, hasnt needed (funds from the governments Troubled Asset Relief Program), hasnt needed special assistance and is still completely self-sustaining,” Stevens said.

“Without FHA there would be no (housing) market, and this economys recovery would be significantly slower,” he said.

The FHA has insured nearly a quarter of all new loans made this year, and about 80 percent of that business is from first-time homebuyers.

The agencys dominant role in first-time home purchases has raised questions about whether it taking on too much risk. Some have drawn comparisons between FHA and the subprime market, which collapsed due to homebuyer defaults on risky loans.

Stevens rejected such comparisons, stressing that the agency has far more stringent guidelines for the loans it insures.

“Nothing could be further from the truth,” he said.

FHAs losses have increased with the unemployment rate as more homeowners default on their loans. About 17 percent of FHA borrowers are at least one payment behind or in foreclosure, compared with 13 percent for all loans, according to the Mortgage Bankers Association.

An independent audit shows FHAs reserves have fallen to $3.6 billion, compared with $685 billion in outstanding insured loans for the fiscal year ended Sept. 30. Thats a ratio of 0.53 percent and far below the 2 percent threshold required by Congress.

“That is why were still standing while many of others did not survive this tumultuous time,” he said.

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