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THE MORTGAGE MACHINE
would happen to its loans under various scenarios—for example, if interest rates
went up or down or if house prices dropped , even . “For a quarter of a cen-
tury, it worked exactly as the simulations showed that it would,” Sandler said. “And
we have never been able to identify a single loan that was delinquent because of the
structure of the loan, much less a loss or foreclosure.” But after Wachovia acquired
Golden West in and the housing market soured, charge-offs on the Pick-a-Pay
portfolio would suddenly jump from . to . by September . And fore-
closures would climb.
Early in the decade, banks and thrifts such as Countrywide and Washington
Mutual increased their origination of option ARM loans, changing the product in
ways that made payment shocks more likely. At Golden West, after years, or if the
principal balance grew to of its original size, the Pick-a-Pay mortgage would
recast into a new fixed-rate mortgage. At Countrywide and Washington Mutual, the
new loans would recast in as little as five years, or when the balance hit just of
the original size. They also offered lower teaser rates—as low as —and loan-to-
value ratios as high as . All of these features raised the chances that the bor-
rower’s required payment could rise more sharply, more quickly, and with less
cushion.
In , Washington Mutual was the second-largest mortgage originator, just
ahead of Countrywide. It had offered the option ARM since , and in , as
cited by the Senate Permanent Subcommittee on Investigations, the originator con-
ducted a study “to explore what Washington Mutual could do to increase sales of Op-
tion ARMs, our most profitable mortgage loan.” A focus group made clear that few
customers were requesting option ARMs and that “this is not a product that sells it-
self.” The study found “the best selling point for the Option Arm” was to show con-
sumers “how much lower their monthly payment would be by choosing the Option
Arm versus a fixed-rate loan.” The study also revealed that many WaMu brokers
“felt these loans were ‘bad’ for customers.” One member of the focus group re-
marked, “A lot of (Loan) Consultants don’t believe in it . . . and don’t think [it’s] good
for the customer. You’re going to have to change the mindset.”
Despite these challenges, option ARM originations soared at Washington Mutual
from billion in to billion in , when they were more than half of
WaMu’s originations and had become the thrift’s signature adjustable-rate home loan
product. The average FICO score was around , well into the range considered
“prime,” and about two-thirds were jumbo loans—mortgage loans exceeding the
maximum Fannie Mae and Freddie Mac were allowed to purchase or guarantee.
More than half were in California.
Countrywide’s option ARM business peaked at . billion in originations in the
second quarter of , about of all its loans originated that quarter. But it had
to relax underwriting standards to get there. In July , Countrywide decided it
would lend up to of a home’s appraised value, up from , and reduced the
minimum credit score to as low as . In early , Countrywide eased standards
again, increasing the allowable combined loan-to-value ratio (including second liens)
to . 
