"Washington Mutual Inc., the nation’s largest savings and loan institution, was so badly burnt by the mortgage meltdown that it needed a $7 billion infusion of capital from the private equity firm TPG Capital and other investors to stay independent.

Although the Seattle-based thrift may ultimately still not survive, Kerry Killinger, its chief executive officer, will do just fine, thanks to the largesse of the board, which approved a compensation structure shielding senior management from the impact of the mortgage crisis.

Killinger received more than $14 million in compensation in 2006. Although he refused a bonus in 2007 because of the company’s poor performance, the 2008 proxy reveals that Washington Mutual more than made up for that by giving Killinger a hefty grant of stock and options awards valued at close to $13 million. This was on top of a base salary of $1 million, proving that the alignment between pay and performance is completely broken.

Washington Mutual also is protecting the compensation of its senior managers in the current year from any hits from the mortgage crisis. The thrift changed the performance measures of its 2008 bonus plan to exclude the effects of loan loss provisions, expenses related to business resizing or restructuring and expenses related to foreclosed real estate assets.

This at a time when Washington Mutual reported that it would lose $1.1 billion in the first quarter of 2008 and set aside a provision for loan losses of $3.5 billion. The thrift also said it would slash its quarterly dividend from 15 cents to a penny and give pink slips to 3,000 employees.

CreditSights Inc. warned on March 27 that the company could lose $4.2 billion this year due to increasing losses on mortgages and may have to raise at least $3 billion in capital to meet federal regulatory requirements.

The dilution from the infusion of capital by TPG and other investors is further punishment for Washington Mutual’s shareholders who had already lost 70 percent of their investment in 2007 and seen their dividend slashed by 73 percent.

The company’s biggest stumble “was a late entry into the subprime market as a way to juice the once fast-growing company’s sluggish earnings,” The Wall Street Journal noted. Despite a series of missteps by Killinger, the board approved an executive compensation structure to protect his pay package and that of other senior managers from the impact of the mortgage crisis.

Killinger’s 2008 equity award will be approximately 15 percent greater than his 2007 award and consist solely of performance-vesting stock options. Stock option grants provide senior executives with incentives to enhance the stock’s short-term performance to the detriment of long-term shareholders. Stock option grants promise executives all the benefit of share price increases with none of the risk of share price declines.

In an April 4 report, RiskMetrics Group’s ISS Governance Services recommended that shareholders support a campaign by the AFSCME Pension Plan and the CtW Investment Group to vote at the April 15 annual meeting to throw out all the directors on the board finance committee. The proxy voting service also called for shareholders to support the installation of an independent chairman and for the requirement that directors get a majority of the vote for election to the board.

The RiskMetrics report also questioned Killinger’s continued leadership. “Given the magnitude of the company’s losses and recent changes in the executive suites at Citigroup and Merrill Lynch, we question why the board did not replace Mr. Killinger as CEO, particularly given the critical strategic decisions that the company still faces.” Washington Mutual decided in 2006 to focus its mortgage business increasingly on higher-margin products, despite the recognition by analysts of the risk “inherent in the mortgage franchise.” These higher-margin products include option payment adjustable rate mortgages, alt-A loans and below prime loans. These higher-margin loans also are riskier. Among the largest U.S. mortgage lenders that year, Washington Mutual also made the highest proportion of loans to real estate investors and second-home buyers. Such loans are considered especially risky.

Not only did Washington Mutual increase lending to risky borrowers, it may have done so in questionable ways. Last November, New York Attorney General Andrew Cuomo filed a lawsuit against eAppraiseIT, the appraisal arm of First American Corp., alleging that it inflated the value of homes nationwide in response to pressure from Washington Mutual. Cuomo’s lawsuit also attracted the attention of the U.S. Securities and Exchange Commission and the Office of Thrift Supervision.

Appraisals ascribe a value to property that determines the amounts that banks are willing to lend to the buyer. Mortgage brokers and lenders then collect fees based on the dollar value of the loans they make to the buyer of the property.

This means that in addition to its involvement in what is possibly illegal activity, Washington Mutual has a mortgage loan portfolio of lower quality than previously thought to be the case. The company now faces a higher risk of credit losses as homeowners are stuck with homes whose true value is much less than they thought and with mortgages they can’t pay.

Washington Mutual’s aggressive lending practices began to reveal their true value when losses began to mount. The company reported a $1.87 billion loss in the fourth quarter of 2007. Moody’s Investors Service cut the company’s credit rating to a notch above “junk.” The lower credit rating indicates that investing in Washington Mutual is considered to carry a higher risk than before. Toward the end of 2007, the company announced it would lay off 3,300 of its 50,000 workers.

Instead of properly monitoring risk, Washington Mutual has followed lending practices that make risk more difficult to identify and structured management’s compensation to sidestep the consequences, a scary proposition considering that further write-downs are expected. According to some estimates, the company will need $8 billion to cover borrowers who can’t afford their mortgage payments, although Moody’s estimated that the company might need as much as $12 billion.

And what if Washington Mutual goes the way of Bear Stearns or Countrywide? Killinger should have no worries, with a golden parachute worth more than $22 million, if he is terminated before a change in control."