Friday, September 26, 2008

This Week's Largest Bank Failure in U.S. History

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Last night, Washington Mutual became the biggest bank failure in American history when it was closed by the Office of Thrift Supervision (its $307 billion in assets dwarfs the previous record holder, Continental Illinois, which had only $40 billion in assets) . The FDIC was immediately named as receiver and it just as immediately sold Washington Mutual to JP Morgan Chase. The only surprise in Washington Mutual's failure was that it took place on a Thursday instead of the usual bank seizure day Friday (the situation must have really been desperate), although based on news reports, the CEO seemed to have been unaware that it was going to happen. There was a major surprise however in that the FDIC claimed that it will not have to pay any money out of its deposit insurance fund because of the failure (this doesn't mean that the money isn't going to be paid, see below for some insight into the latest scam that the U.S. government seems to have going).

The New York Investing meetup first predicted Washington Mutual would go under last April and again in our September meeting (it was amazing it was still operating at that time). Its impending failure was an open secret in the last few weeks. A slow run on the bank followed, with $16.7 billion (or approximately 12%) of deposits being withdrawn since September 15th. While filings indicate that Washington Mutual had $143 billion in deposits at the end of August and deposits were likely dropping in the first 15 days of September as well as after, the government stated in its takeover press release that Washington Mutual had $188 billion in deposits (interesting arithmetic, but typical of the U.S. government).

Washington Mutual had all the major markers of a bank likely to go under - a huge drop in the stock price (down 95% from the high yesterday); option ARM and subprime lending (as much as half of its $227 billion in loans; massive losses ($3 billion in the last quarter alone) and write downs; a fired CEO; way above average interest rates to get deposits (5% for one-year CDs), and incidents of capital raising. Unlike other failure prone banks, Washington Mutual had only one major capital raising event because the terms granted private equity firm TPG made it impossible to raise additional funds. TPG agreed to rescind those terms a couple of weeks ago, but too late to save the $7 billion it funnelled into the doomed Savings and Loan last April (once again the 'smart' money doesn't seem so smart after all). There was even an additional augur of Washington Mutual's impending end that can not be reliably counted on - S&P downgraded it to junk status on September 15th and then again to even lower junk status on the 24th (with ratings as low as C, only one step above the minimum possible D, which means default). Kudos to S&P for finally downgrading a company before it went out of business.

As for the terms of JP Morgan's takeover, they are quite interesting to say the least. JP Morgan agreed to pay $1.9 billion for the acquisition (similar to the price it paid for Bear Stearns). It has no obligations to Washington Mutual's equity, senior, or subordinated debt holders, all of whom will be wiped out. It is going to have to take a $31 billion write down for Washington Mutual's bad loans however. This figure is approximately what the FDIC would have had to pay out of its deposit insurance fund because of Washington Mutual's failure. It is doubtful though that JP Morgan will really suffer the full cost of this write down. It not only has a major account with the Federal Reserve, but its CEO, Jamie Dimon, has a seat on the New York Fed's board and gets to vote on decisions that could be very helpful to his bank. Somehow, I think the Fed will make sure that JP Morgan is taken care of.


Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:


Banks are doomed to fail sooner or later.