TOPICS > Economy

Largest Bank Failure in U.S. History Preempts Any Bailout Plan

September 26, 2008 at 6:25 PM EDT
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Another blow was dealt to the ailing American finance system as Washington Mutual Bank was seized overnight by the U.S. government. By morning its assets were sold off to JPMorgan Chase. Business reporters detail the sudden and drastic move.

JEFFREY BROWN: It was the largest bank failure in U.S. history, as overnight federal regulators seized Washington Mutual, the nation’s largest savings and loan, with more than $180 billion in deposits.

But in a quick turnaround, the Federal Deposit Insurance Corporation then sold Washington Mutual to JPMorgan Chase.

To walk us through this, we turn to Roben Farzad, senior writer and columnist for BusinessWeek who joins us tonight from Richmond, Va.

Well, Roben, first, give us a little background on Washington Mutual, a little bit about its history, and how did it get so big?

ROBEN FARZAD, BusinessWeek: Jeff, Washington Mutual actually was, oddly enough, on its 119th anniversary, I believe today, of its foundings in the Pacific Northwest a long, long time ago, in 1889.

But, really, the ’90s were the boom-boom decade for this company, in that it went from being a sleepy little thrift and securities arm to buying Great Western Bank, which was big in the West Coast, and then parlaying that into a string of dozens of acquisitions, which then got it fat on cheap deposits.

And then, lo and behold, the mortgage market starts skyrocketing, and that got it flush at first, but cocky, as we know, which is what happened to other firms, and it ended up making a lot of bad loans that it thought would be better loans.

Large bank involved in sub-primes

JEFFREY BROWN: Well, tell us -- well, that's where I wanted to go. How did it get in trouble, along with everyone else, clearly? But what specifically did it do to get into such trouble?

ROBEN FARZAD: Well, the beginning assumption is you wonder if the tail wags the dog, because a company with -- I think it was last clocked at having $188 billion in deposits.

You just don't sit on that money. You don't just stick it in short-term treasuries and content yourself with a couple of points of interest. You want to loan that out and feast on that interest margin.

And when the market starts to get complacent, for example, I've loaned all the available money I can out to prime, quality borrowers that I can get less interest for, you are essentially emboldened to take up your risk profile. "Well, let's go down the food chain."

Subprime doesn't look so bad, because home prices are going up, because there are new innovations in subprime mortgages, certain mortgages with asterisks attached to them, option ARM mortgages, big toggle mortgages, all these other creative products, jumbo interest only mortgages.

As long as home prices were going up -- and how many times have we told this story in the past year -- they were fine. And as long as they could sell these mortgages down the food chain to Wall Street, to other firms that could then securitize them and sell them to institutional investors, it was more kind of out of sight, out of mind.

But as we all know, that music ended abruptly a year ago. And you're stuck holding the loans that you made.

And, unfortunately, WaMu decided that it really -- you know, ultimately these loans were just terrible loans, and it depleted its capital base, and it has this vicious cycle-type effect, where suddenly everybody thinks that WaMu is going to be the next big bank to fail, so it's a self-fulfilling prophecy.

They pull their deposits out to the tune of $17 billion just in the past 15 days. So then your perception becomes a reality, and it just feeds on itself until the feds have to swoop in.

FDIC stepped in, brokered deal

JEFFREY BROWN: Well, so they swoop in. The FDIC took control last night, rather dramatically, and then quickly sold it.

Now, why does it take the FDIC -- why not just a straight sale? Why does the FDIC jump in?

ROBEN FARZAD: You know, WaMu amazingly had many chances to sell itself as a going concern, as a solvent company. JPMorgan actually approached it months ago and offered $4 a share. The company didn't want to throw in the towel then.

We've seen this time after time. It happened with Lehman. It happened with other firms in distress. There's this kind of tragic Greek confluence of hubris and denial. And it's just, "I'm not going to give these assets to you for pennies on the dollar."

Well, Jamie Dimon, actually, the CEO of JPMorgan, he turns out to be a much more deft negotiator. And he realizes, "The longer we go into this and the worse it gets, these guys are going to have less of a bargaining position, and I can come in when they're on death's doorstep."

And that's what happened, in fact, so much so that management of Washington Mutual was on a flight, a cross-country flight, and the feds seized it and took over the bank regardless. They had a deadline until about Wednesday to solicit offers for the parts of the company from other banks. Other banks passed.

And the feds and Jamie Dimon, once again, JPMorgan is the buyer of last resort, and he swept in and got a custom-tailored deal, where he got effectively the choice cuts of meat, and he was able to leave the gristle on the table.

So while it remains to be seen how this plays out for JPMorgan Chase, certainly it's kind of second masterstroke with the help of the feds.

JEFFREY BROWN: Now, one good thing, I guess, is that, with the quick sale, the quick turnaround sale, the FDIC doesn't get hit for its deposit fund anymore. So the depositors, the customers of Washington Mutual are not hurt at all, right, or are they?

ROBEN FARZAD: It's seamless. They are not hurt. In fact, we see how this thing happens. There have been about 12 bank failures so far this year. IndyMac was by far the largest so far, and this just totally eclipses that.

They come in and very quietly Friday afternoon, if you're, you know, still following the news, you find that, oh, by the way, feds seized this bank. You typically never heard of this bank out of the Midwest or the South. And then so the integration is rather seamless by Monday.

It would be a far different beast with something the size of WaMu, with $188 billion in deposits, 2,300 branches, 15 states. That would just cause just a systemic ripple and almost a daisy-chain reaction. Other banks would fail.

I think the feds, to their credit, and the FDIC really wanted to get ahead of the ball this time and not allow a bank's failure to really force their hands, because WaMu's failure certainly could have brought several other bank failures with it.

And that would have, you know, in one fell swoop depleted the entire insurance fund of the FDIC.

Connections to toxic loans complex

JEFFREY BROWN: Deplete or put a big strain, how serious?

ROBEN FARZAD: Well, if other banks -- I mean, it's hard to interpolate that. WaMu by itself may not have done it, because we don't know yet how much of its deposit base was uninsured.

But if others failed in tandem with WaMu, because WaMu was a counterparty to them, or they just realized, "Wow, if we're on the hook for all these other cross-party obligations to WaMu, we'd better throw in the towel," you could have seen, you know, several other banks fall.

I mean, this is all hypothetical at this point and looking back is hardly 20/20, but the feds obviously, with a lot of moving parts this week, did not want to take that chance.

And it also underscores why the government is looking for some sort of omnibus deal that would come in and take all the toxic assets off the books.

So, you know, with all those moving parts, if you're the FDIC, do you want to take a chance and say, "Let's let the free market just take apart WaMu and let's deal with the conflagration later?" I think, in this environment, you certainly don't want to leave anything to chance.

JEFFREY BROWN: All right, and, briefly, Roben, while the customers come out OK, shareholders are wiped out and employees, I guess, are a big question mark?

ROBEN FARZAD: Yes. It is a big question mark, because JPMorgan, you can imagine, there are lots of redundancies here. I mean, if, for example, in New York, you walk up and down Broadway on the Upper West Side, all the big major cross avenues have pretty much invariably, WaMu is next door to Chase Banks, next door to HSBCs and Citibanks.

There's going to be an enormous -- there's enormous overcapacity right now. The entire banking system vastly overestimated the demand for these retail products.

But if JPMorgan plays its hands right, it's going to consolidate this business. And moreover, Dimon is realizing he can parlay this into a reputational boost.

If people realize that JPMorgan Chase is strong enough to come in and almost act as a quasigovernmental organization, I think it only underscores the case for transferring assets to JPMorgan, which, right now, chief bank deposits that you and I make are the entire lifeblood of the system, because the credit market is dried up.

So the bank with the most assets, in terms of cheap deposits, wins at the end of the day. And, unfortunately, that leaves out shareholders at this point of WaMu.

If I was a WaMu shareholder, I would be livid that management passed on multiple chances to sell the company at a higher price. And, by the way, creditors are being left out, as well.

So there's a lot of blood on the streets. This is by no means a total rescue that makes everybody happy. But considering that these guys swooped in under very tricky circumstances, on Wall Street and in Washington, it's miraculous that they were able to stage this controlled demolition of sorts.

JEFFREY BROWN: All right, Roben Farzad of BusinessWeek, thanks very much.

ROBEN FARZAD: Thank you, Jeff.