(This is Part 2 of a two-part series. Read Part 1, "WaMu failed to heed lesson learned in ’80s.")

Kerry Killinger, the former strategist at the brokerage firm Murphey Favre, became Washington Mutual’s chief executive in 1990. He made his first significant money by flipping investment homes in eastern Washington state and deeply believed in the power of the housing industry.

Killinger was all about the business of mortgages and engineered the bank purchases that would make WaMu the nation’s largest residential lender. In the end, it was a loan — "the only loan you’ll ever need" — that brought the bank down along with the customers who yanked their deposits because of the loan’s reputation. Killinger was removed as chairman just before the bank was handed over to the Federal Deposit Insurance Corp. and sold off to JP Morgan Chase in the biggest failure in U.S. banking history.

The option adjustable-rate mortgage (ARM) will be the loan that will be blamed for Washington Mutual’s demise. The bank believed the loan was a creative mortgage that would help a variety of borrowers in various stages of their lives. The loan gave borrowers more choices over monthly payments each month, thus providing an opportunity to "flip-flop" payments according to household cash flow. Because of its flexibility and versatility, it was promoted as "the only loan you’ll ever need."

After the initial start period, customers could select among four payments plans each month during the life of the loan. Borrowers are never locked into one specific payment or amount, leaving open the possibilities of pulling back during a money crunch or shelling out more after an unexpected windfall.

Here were the options in a capsule.

  • Minimum payment: This is a very low payment that leaves you more cash during lean months. However, at times the payment amount may not be enough to cover the interest portion of the loan. If so, that amount would be added to your original loan.
  • Interest-only payment: The payment still is low, yet you pay only the interest portion and any deferred interest that may have accrued. While you do not reduce the original loan amount, you do not "go backwards" or owe more than you borrowed.

Many consumers and brokers simply didn’t "get" all of WaMu’s options. Others clearly understood but were motivated by attractive commission fees or the possibility of living in a home they could not truly afford. The bank kept accepting the loans from just about all who wanted to opt in. Now, many consumers simply can’t opt out.

To get even more valuable advice from Tom, visit his Second Home Center.

***

What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

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