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updated 4/12/2010 7:10:09 PM ET 2010-04-12T23:10:09

The mortgage lending operations of Washington Mutual Inc., the biggest U.S. bank ever to fail, were threaded through with fraud, Senate investigators have found.

And the bank's own probes failed to stem the deceptive practices, the investigators said in a report on the 2008 failure of WaMu.

The panel said the bank's pay system rewarded loan officers for the volume and speed of the subprime mortgage loans they closed. 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 Tuesday by the investigative panel of the Senate Homeland Security and Governmental Affairs Committee.

Sen. Carl Levin, D-Mich., the chairman, said Monday the panel won't decide until after hearings this week 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 September 2008.

The report 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 bank's President's Club, with trips to swank resorts, such as to Maui in 2005.

Fueled by the housing boom, Seattle-based Washington Mutual's 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, collapsed in September 2008. It was sold for $1.9 billion to JPMorgan Chase & Co. in a deal brokered by the Federal Deposit Insurance Corp.

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

WaMu was one of the biggest makers of so-called "option ARM" mortgages. These mortgages 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.

The panel is holding hearings Tuesday and Friday to take testimony from former senior executives of Washington Mutual, including ex-CEO Kerry Killinger, and former and current federal regulators.

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 weren't 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 company's 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 bank's 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.

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

In late 2006, Washington Mutual's 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.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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