WASHINGTON — As the Senate prepares to debate regulatory reform legislation, Sen. Carl Levin is using the failed Washington Mutual Inc. as evidence that the bill's most contentious provisions are necessary.

The chairman of the Permanent Subcommittee on Investigations is prepping four hearings related to the financial crisis, the first of which is scheduled April 13 and will focus on Wamu's risky lending practices.

Based on an 18-month investigation, Levin said, he believes that certain provisions of the reform legislation, such as the creation of a consumer protection agency and a requirement that lenders maintain a stake in loans they sell to the secondary market, could have helped avoid, or lessen the impact of, the thrift company's failure.

"A lot of proposed reforms will gain additional support, we believe, from these findings," Levin said. "It is my hope that these hearings, these findings, give a boost, a momentum to strong regulatory reform in many, many different ways."

Levin began his investigation in November 2008, two months after Wamu's failure. The panel did more than 100 interviews and collected millions of documents, some of which are to be released today.

The investigation focused on four areas — lending practices at Wamu, supervision by bank regulators, credit rating agencies and investment banks. Levin argued that Wamu is a case study in poor lending practices that infected the entire banking industry. Today's hearing is to feature past executives, including Kerry Killinger, Wamu's former CEO, while a hearing scheduled Friday assesses more broadly the banking agencies' performance during the crisis.

During a press conference Monday, Levin said the $300 billion-asset Wamu failed because of poor underwriting, an aggressive appetite for securitization and compensation incentives based on the quantity, not quality, of loans.

Senate Banking Committee Chairman Chris Dodd's reform bill could have prevented some of the damage to the thrift, Levin said. For example, he argued, the proposed consumer protection agency would probably have banned some of the most egregious products, including negatively amortized loans, and ensured that lenders did not make mortgages that borrowers could not repay. "There is no good purpose served by having people pay less than the interest owed," said Levin. "I don't know if there would be amendments to this, but I would certainly support an amendment that prohibited the negatively amortizing loans."

Risk-retention is just as critical, he said. The Dodd bill would require lenders to keep at least a 5% stake in any loan they sell to the secondary market.

"To do shoddy loans and pass along the risk — that is what happened here by the billions," Levin said. "There are a lot of ways to stop that. One way is to require securitizers to maintain [ownership of] a percentage of the securities that they issue."

Levin said Wamu was one of many banks that sold loans to the secondary market in order to remove risk from its books.

"This hearing is less about Wamu's failure than it is about a pattern of selling toxic mortgages into our financial system, poisoning the secondary market," he said. "That market had a huge appetite for subprime and high-risk mortgages. The quality was not the key thing. It was whether or not they could get a stamp of approval and it could be sold. These toxic sales upstream played a central role in the financial crisis."

Levin pointed the finger solidly at Killinger for Wamu's collapse, arguing that in 2005, the former chairman and CEO shifted the thrift's focus from fixed-rate mortgages to subprime and other risky loans. In 2003, Wamu's originations were 64% fixed-rate products, 7% option adjustable-rate mortgages, 7% home equity loans, 5% subprime loans and 17% other ARMs, according to Levin.

By 2006, 25% of Wamu's loans were fixed-rate, 22% were option ARMs, 17% were home equity loans, 16% were subprime and 20% were other ARMs.

During that time, the bank's sale of such loans to the secondary market grew from $4.6 billion to $29 billion. From 2000 to 2007, the thrift securitized $77 billion of subprime loans.

"Using a toxic mix of high-risk lending, lax controls and compensation policies which rewarded quantity over quality, Washington Mutual flooded the market with shoddy loans that went bad," Levin said. "It built a conveyer belt that dumped toxic mortgage assets into the financial system like a polluter dumping toxic substances into a river. Down river was Wall Street with its huge appetite for these mortgage-backed securities that bottled that polluted water."

Wamu's subprime lending unit was Long Beach Mortgage Corp. A Federal Deposit Insurance Corp. review in 2003 of 4,000 Long Beach loans found that less than one-quarter could be properly sold to investors, and a 2005 review, which was shared with management at Wamu found fraud in 58% of the loans in two of Wamu's top-producing retail loan offices. Documents revealed that Long Beach and Wamu loans did not comply with the bank's own credit requirements, contained erroneous borrower information and suffered from early defaults.

Levin produced documents and e-mails showing that Wamu employees and regulators were aware of the problems at Long Beach.

Long Beach Mortgage "is terrible … repurchases, [early payment defaults], manual underwriting, very weak, servicing/collections practices and a weak staff," Stephen Rotella, the former president and chief operating officer of Wamu Bank, wrote in an e-mail on April 27, 2006.

An e-mail from David Schneider, the former president of home loans at Wamu, said, "We are all rapidly losing credibility as a management team."

Levin said the thrift also originated and securitized loans it identified as likely to go delinquent without disclosing this to investors who bought the securities and that it securitized loans with information known to be fraudulent.

Though Levin was most critical of the bank's management, he also blasted Wamu's regulator, the OTS. The agency, which would be merged into the Office of the Comptroller of the Currency under the Dodd bill, allowed Wamu to avoid following nontraditional mortgage guidance for a year because the thrift claimed a provision would cost it one-third of its business.

Levin also criticized the thrift's compensation structure. Employees who produced the most loans were rewarded with membership in the "President's Club," which sponsored lavish trips to Hawaii. Magic Johnson once led an event there, and entertainment included a song called "I Like Big Bucks."

"The financial disaster was not a natural disaster," Levin said. "People with extensive greed was the driving force, and it will happen again unless we change the rules."

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