SEATTLE–It remains the largest-ever failure by a U.S. financial institution—and it offers valuable lessons for credit unions in how a board failed in its duties.
Just ask someone who was there, who now serves on a credit union board, and who very much wants CU directors to heed those mistakes.
Bill Longbrake, who serves on the board of BECU here and who has a long and distinguished career in financial services, was an executive at the former Washington Mutual Bank, having joined it in 1982 when he recalled it acted much like a credit union. Over the following two decades, however, Washington Mutual, better known as WaMu, would convert to a bank, see stratospheric growth, and then crash.
It’s a crash, said Longbrake, who is now the executive in residence at the University of Maryland’s Smith School of Business, that can largely be attributed to a failure of culture and governance by the board. Why does a bank’s failure matter to credit unions? Because the credit union movement in the U.S. is for the most part also enjoying robust growth—the kind of growth that can lead to complacency and blind boards to emerging risks.
Longbrake’s comments were offered during a Symposium on Current Issues in Credit Union Board Governance that was organized by John Lass, who leads Lass Advisory Services and consults with many credit unions, along with former CU exec and regulator Parker Cann, and the law firm Foster Pepper.
Foster Pepper hosted the Symposium at its Seattle offices, and has ties to Washington Mutual, which had $307 billion in assets at the time it was seized by regulators in September of 2008. It was eventually sold to JPMorgan Chase for $1.9 billion. The co-founder of the firm, Lou Pepper, had been brought in to turn it around in the early 1980s when it was still a thrift. Pepper and the board then hired a CEO who would change WaMu’s culture and deliver double-digit returns, before it eventually failed.
“I have come to the view that diligent board governance is critical to the success of any organization,” said Longbrake. “You have a responsibility as board directors to make sure it’s the right culture, it’s sound, and it’s preserved.”
A Wrong Turn
“Washington Mutual was very much like a credit union when I joined it in 1982,” continued Longbrake. “It was very much a mutual in culture and orientation. It was member-centric. It converted to a bank charter and success proved fleeting. It failed because its culture was corrupted, its strategy took a wrong turn, its external environment changed, and the board was asleep and did not pay attention. I can’t emphasize enough the importance of the board paying attention. If things are going well and you like the management, don’t go to sleep. The world can change quickly.”
Organizational Culture
What is culture? Longbrake defined it as a “system of basic, shared assumptions of meaning/purpose within an organization shaped by internal and external opportunities, and challenges that are internalized by members/employees).
(Note: in his remarks, Longbrake used the word “members” to reference members of the organization, primarily employees.)
The attributes of culture, he said, are:
- Passes across generations of members.
- Stable over time, and changes usually occur slowly and in small increments. (Change can accelerate in the face of existential threat.”
- Why employees/members work is what determines how well they work (also known as the importance of engagement). “It provides members with a way of giving meaning to their daily lives, and sets guidelines and rules for how to behave. It also provides/contains anxiety of dealing with an unpredictable and uncertain environment.”
What types of cultures are there? Longbrake said the most typical is the “strong” culture in which there are basic assumptions widely shared and held by members. But, there are also cultures based on fear and stress, which are largely negative, yet which also can create strong performance, but typically not over an extended period of time, he said.
Consensus and endorsement of values and norms facilitates social control, according to Longbrake, explaining that internal social control is more effective and lower cost than formal control structures.
While a credit union may aspire to a “strong” culture, it must recognize there are associated risks, Longbrake stressed, especially in the kind of financial services marketplace now in place.
“Strong cultures may hinder timely adaptation when a culture’s basic assumptions conflict with rapidly changing external environments,” he said, pointing to what has happened with advent of smartphones and in payments. “This is something as a director to be vigilant about.”
How does a credit union create and maintain a strong culture? It begins with selection, where members’ personal attributes “fit” the culture, he said, adding it’s hard to maintain in large, complex organizations with a large number of members passing in and out.
“Cultures are more likely to exist if they are institutionalized,” he said.
To reinforce a strong culture, rewards and incentives must reinforce the desired outcomes and can be damaging when they motivate work rather than work well done, he added.
Leadership Behaviors
The leadership behaviors to build a culture, said Longbrake, require:
- Purpose. To help members understand how his/her work is important and meaningful.
- Signals. To make it clear what it means to be performing well.
- Storytelling and Rituals.
- Generate Commitment. To provide members with more responsibility as his/her skills increase.
Longbrake said successful cultures must recruit, select, promote and retire in support of the culture. Leadership must also encourage experimentation and meaningful work and resist “the urge to over-engineer.”
So, what happened at Washington Mutual, where Longbrake was a risk officer? In the early 1980s, the bank had about $2.5 billion in assets, but it was at risk of failing as the result of bad loans and asset/liability problems. When the board realized what was going on, it brought in Lou Pepper to lead the organization on an interim basis.
“Lou Pepper’s charge was to save the bank from failure, or sell it,” said Longbrake.
While organized as a mutual bank, Washington Mutual went public in March of 1993 as part of its survival plan.
“In a crisis situation, you do whatever you can to achieve survival,” said Longbrake, “and the most important thing Lou did was turn around employee morale. He also took actions to cut costs, imagine the future and convert from mutual to stock ownership. But he did something else, and that was to talk about the future and the type of financial institution it wanted to become. Lou’s vision was to develop a ‘Consumer Bank’ and to satisfy most consumer financial needs in one place while focusing on amazing customer service. He changed culture from ‘sit and serve’ to ‘go and sell.’”
The Foundation
In addition, according to Longbrake WaMu built its foundation on:
- A crisp, focused mission and strategy to “Do a few things well.”
- Solid values, balancing shareholder, customer, employee and community needs that are reflected in its brand.
- A strong infrastructure with good information, performance measurement, technology and streamlined processes.
- Build an executive management team that has the right people on the bus.
- Empowering employees to do what’s right for the customer. “Engaged employees act like owners.” This is reinforced through values, along with ethics, respect, teamwork, innovation and excellence. And those, in turn, are built through compensation programs.
The organization’s values at the time were respect, teamwork, innovation and excellence, said Longbrake.
Things Start Changing
But that began to change when WaMu hired Kerry Killinger as its new CEO, and for more than a decade Killinger would be hailed as an outstanding business leader and a stalwart in the Seattle community, before finally being fired 17 days before WaMu was placed in conservatorship.
Beginning in the early 1990s it became an era for WaMu and other financial institutions of growth through acquisition (“eat or be eaten”) and new products, especially free checking.
Now that the institution was shareholder-driven, Killinger and WaMu embarked on designing products around customer pain points, and with checking that meant no minimum balance requirement, no monthly fees/transaction charges, and no embarrassment from bounced checks (but fees for overdrafts), Longbrake said. He recalled in that era there was a lot of criticism from other banks over offering checking free.
“It was all about human psychology, and our competitors didn’t get it,” he said. “We brought in lots and lots of new accounts, and those became the linchpin for other accounts.”
WaMu grew from $7 billion in assets in 1993 to $270 billion by 2002, including a number of acquisitions large enough to double assets with each purchase.
From 1996-2002, earnings rose at 20% per year. But the competitive environment changed. Longbrake noted major competitors began to copy WaMu’s free checking offer, began to build similar new branches, and there were no more “sleepy thrifts” to be acquired. All that led WaMu, which positioned itself somewhere between being a thrift and a commercial bank, to look for a new growth driver, which it found in a new strategy that it was now somewhere between being a mortgage banker and a portfolio lender.
The bank also began to hold riskier loans on its balance sheet.
'Detrimental' Moves
But there were also cultural changes taking place inside the bank as it sought to keep its strong earnings performance on track. Management “did not think through” the changes, and that became “detrimental,” according to Longbrake.
WaMu moved from its previous values to being dynamic, driven, fair, caring and human. But the first two drove everything, and as one former trainer at WaMu posted on LinkedIn: “The goal was to change the culture from one that as 50% person/support and 50% task/achievement to one that was at least 80% task/achievement. The problem with that kind of culture is that it becomes all about greed and ethics can be thrown out the door, and that was what happened.”
Compensation programs at WaMu also changed as it became all about maximizing personal income. “Sales people have very little allegiance to the company,” he noted.
When it came to a chief responsibility of the board, overseeing the CEO, Longbrake reiterated that the board didn’t do its job. He credited the CEO with being a strong visionary, having a marketing/promotional communication style, with being a powerful motivator and with being highly analytical. But the CEO also avoided conflict and confrontation, and could be indecisive in resolving operational issues.
“Constructive conflict” at the company, said Longbrake, was discouraged. “The CEO weaknesses took on increasing importance over time,” he said. “Don’t fall in love with your CEO, no matter how great he or she is. Are they coasting on history? Complacency is one of the worst sins of board governance.”
Why Did No One Raise a Hand?
In 2004, Longbrake was WaMu’s first risk officer, and he observed that, “Traditionally, you look at risk on two levels: internal, which is internal auditing, and compliance. That’s all about the minutiae. But for board members, there is another part of risk management that is important, and that’s the big picture, what I call the strategy risk. You do need to make sure you pay attention to the bigger issues and what is happening in the marketplace.”
When things started turning south at WaMu, did anybody in management or on board raise their hand and say there is a problem? Nobody other than himself, said Longbrake, who said he was soon steered into a less-influential position at the bank. What was taking place inside the bank, he said, and what ultimately led to its demise, was its one-time success eventually led to complacency and “group-think,” and, ultimately, to the largest-ever bank failure in the United States in 2008.