Last Monday's Justice Department civil complaint filing against Standard & Poor's and its parent company, McGraw-Hill, for fraudlent rating practices in the lead up to the housing crisis named what was formerly the biggest credit union in the United States as a key part of an ugly story.
Western Federal Corporate Credit Union (WesCorp), based in San Dimas, had $34 billion in assets at its peak. But exposure to residential mortgage-backed securities (RMBS) led to its downfall. Federal regulators took it over in 2009.
The National Credit Union Administration — which assumed control of WesCorp along with four other big corporate credit unions — estimates that current losses because of the credit union's bad RMBS investments amount to $7-$8 billion.
That's a daunting figure when you consider that the NCUA got $11.2 billion from the U.S. Treasury to bail out WesCorp and its brethren (corporate credit unions function for smaller credit unions the way the Federal Reserve does for banks in the U.S.) and has paid back $6.1 billion. WesCorp apparently took the biggest bite out of that loan.
The trade press that covers the credit union world has carefully chronicled WesCorp's decline (you can read the Ray Birch and Frank J. Diekmann's magnum opus from Credit Union Journal on the fall of WesCorp here). The WesCorp meltdown serves as a reminder that another California company - a gigantic credit union - made the Great Recession possible alongside Wall Street powers like Standard and Poor's, Lehman Brothers and Countrywide Financial Corp.
Countrywide and WesCorp were caught up in one of the housing crisis' last unfortunate tangos. Countrywide originated risky mortgages for primary purpose of securitizing them, then sold them to investors like WesCorp, which was trying to accelerate its growth in the early 2000s.
Here's what the Inspector General of the NCUA concluded when it investigated the relationship, according to National Mortgage News:
WesCorp's "concentrations of (residential MBS) with collateral in a single state - California - became excessive," said the [Inspector General].
In addition, a large concentration of WesCorp's RMBS was associated with a single entity: Countrywide Home Loans. As of the annual examination periods between August 2004 and February 2008, Countrywide had the highest single concentrations as originator and servicer of the underlying mortgage collateral within WesCorp's MBS portfolio. Countrywide was also the highest issuer of securities in WesCorp's portfolio except for [on the] June 2007 examination date when it was second behind Washington Mutual Mortgage Services Corp.
For the record, Countrywide nearly declared bankruptcy in 2008 before Bank of America acquired it (and BofA continues to suffer in the wake of that deal). The federal government took over Washington Mutual in 2008, then rapidly sold what had been the largest U.S. savings and loan to JP Morgan Chase.
WesCorp lasted a bit longer. But by 2009 it was a ward of the state and its CEO, Robert Siravo, was on his way to a court battle with the NCUA that wouldn't be settled until late last year (Angelo Mozilo, Countrywide's CEO, was also taken to court, by the Securities and Exchange Commission; he settled for over $67 million plus a lifetime ban from ever again running a public company).
A question the Justice Department complaint raises is whether Siravo was presiding over a corporate credit union that had become, in effect, a hedge fund, seeking ever greater returns by making a huge bet on the RMBS market.
The complaint alleges that S&P knowing rated RMBS more highly than was justified by the degrading quality of the loans that had been securitized (S&P was also rating collateralized debt obligations — CDOs — a sort of next-level-up security, as while a RMBS was backed by mortgages, a CDO could be backed by a pool of RMBS).
If Siravo was running a hedge fund in San Dimas, he was convinced the RMBS market would never fail.
"They were all in," said Dwight Johnston, WesCorp's former chief economist and an early critic of the credit union's commitment to buying up mortgage-backed securities. (He's now chief economist at the California and Nevada Credit Union Leagues.)
However, Johnston said that WesCorp never pushed too far down S&P's ladder of risk.
"The lowest rated thing they ever bought was AA," he said. He added that the the vast majority what WesCorp did buy was rated AAA. (S&P's ratings range from AAA — the highest — to BBB in the "investment grade" category; below that , starting with BB and going all the way to D for default, rated securities are classified as "non-investment grade" or more colorfully, "junk bonds.")
Johnston pointed out that ratings agencies could regard a security highly at first, but could downgrade them as S&P examined the underlying assets. When it came to the RMBS that WesCorp bought, "they were rated AAA when they bought them," he said. "And after 2005, they bought nothing that was AA."
Johnston said the ratings agencies were obviously part of the problem. But so was the federal government, in his estimation. Not to mention Wall Street, for dreaming up the securitization machine in the first place.
"There's enough blame to go around. But WesCorp is definitely to blame for going all in."
The question remains: Would WesCorp have been able to go all in, gobbling up mortgage-backed securities that S&P and other agencies rated, if Countrywide hadn't been there to feed Siravo's desire to bet big?
I'll try to answer that in a future post.