"The nation’s fourth-largest bank is a bellwether for the mortgage crisis, says Jonathan Weil, an accounting columnist at Bloomberg News. “As long as Wachovia Corp. hasn’t cleaned up its books, there’s probably still more to come,” he says.

Weil says it’s clear that Wachovia hasn’t yet fully disclosed the impact of delinquent mortgage loans on its financial statements because the stock market value of the bank is less than its book value, or net worth. At the end of 2007, the bank’s book value (assets minus liabilities) was $76.9 billion, but its stock market value was only $60.9 billion. “The $16 billion gap shows the market doesn’t believe the company’s balance sheet is holding up,” Weil says.

The banking company’s net income in the fourth quarter of 2007 plunged to $51 million or three cents a share, from $2.3 billion or $1.20 a share a year earlier, and its revenue fell 17 percent to $7.2 billion. Mortgage-related losses were $1.7 billion. Its non-performing assets soared to $5.4 billion on Dec. 31, 2007, from $1.4 billion a year earlier. But the bank’s loan-loss allowance, or the money set aside to cover bad loans, now $4.5 billion, is not large enough to fully cover its non-performing assets.

Despite the bank’s financial woes, G. Kennedy Thompson, chairman and chief executive officer of Wachovia Corp., hasn’t suffered as much financially as the company’s shareholders. Thompson didn’t receive a $5 million cash bonus in 2007 that he got in 2006, but Wachovia granted him stock options and restricted stock with a combined grant date fair value of $14.3 million. This represents a $2.5 million increase or 21.1 percent more than the $11.8 million in equity awards he received in 2006.

Thompson’s compensation illustrates the truism that chief executive officers of large companies typically earn bigger paychecks than heads of smaller companies. The bigger paycheck frequently tempts CEOs to outgrow their competitors through mergers and acquisitions, rather than seeking to financially outperform their competitors. All too often, executives may pursue acquisitions to grow their companies even if the resulting transactions are risky, or poorly conceived. This is what the executives did at Wachovia.

Growth for growth’s sake can be a particularly destructive strategy at a bank, especially if it results in the making of poor quality loans. The banking company, cobbled together from more than 100 acquisitions since 1985, is now the fourth largest bank in the United States. Wachovia executives had financial incentives to pursue this expansion because the company’s executive compensation plan rewards executives for the revenue growth that results from mergers and acquisitions.

As Wachovia has grown, so too has the size of the companies that it considers its peers for executive pay. Like many companies, Wachovia looks at its peer group of rival companies to establish its executive compensation levels. A decade ago, the company, then known as First Union, used the top 25 largest banking companies as an executive compensation benchmark. Today, Wachovia’s compensation committee considers 10 of the largest financial services companies.

Peer group compensation formulas can provide cover for executives when industry-wide problems emerge such as the current mortgage credit crisis. In 2007, Wachovia’s compensation committee concluded that despite Wachovia’s financial exposure to the decline in value of subprime residential mortgages, its peers also had taken significant write-downs.

In May 2006, Wachovia announced the purchase of mortgage lender Golden West Financial for $24 billon. At the time, Thompson praised Golden West for its “singular focus as a risk-averse residential mortgage portfolio lender.” The merger was completed at the peak of the real estate bubble, and since then Wachovia’s stock price has fallen more than 40 percent.

Golden West specialized in offering so-called “option ARM” mortgages that allowed borrowers to select a minimum payment option below the amount of interest due. Golden West often combined these loans into mortgage-backed securities for use as collateral to borrow more money. Adding to the company’s risk, more than 60 percent of Golden West’s outstanding mortgages originated from California, where real estate values reached what many people suspected were unsustainable levels.

Wachovia’s expansion in the residential mortgage business could not have come at a worse time. As the mortgage credit crisis spread in the fourth quarter of 2007, Wachovia’s deteriorating loan portfolio required an increase in its loan-loss provision to $1.5 billion. Wachovia’s quarterly net income fell 98 percent, as its bad loans and delinquencies increased. Unfortunately for shareholders, Thompson has not been penalized for the consequences of the ill-conceived expansion strategy."