The Beauty of Washington Mutual's Collapse

Washington Mutual (NYSE: WM  ) recently became the biggest bank failure in American history. With over $300 billion in assets at the time of its collapse, it easily dwarfed any other doomed bank ever to cross paths with the FDIC. It's quite a tragedy for its employees, investors, and perhaps even depositors who handed the bank over $100,000.

Yet amid the chaos, there is a bright lining to its dark cloud: Not a single dime of taxpayer money will be used to protect FDIC insured deposits at the bank. Instead, JPMorgan Chase (NYSE: JPM  ) bought Washington Mutual's banking business and will make sure those depositors will be covered up to FDIC limits. All this without a bailout plan in place.

Where's the "systemic crisis"?
The speed with which JPMorgan was able to muster its deal after Washington Mutual's collapse does raise questions about the fairness of the transaction. That it happened at all, however, is a testament to the resiliency of the vulture capital market, even amid the current crisis. It worked out, of course, because JPMorgan saw the opportunity to swoop in and make a quick buck on the heels of Washington Mutual's collapse.

Think about that for a second. We just had the biggest American bank failure ever. The headlines are full of paranoid screaming about how financing has completely dried up. Yet somehow a rescue deal was reached in a heartbeat that:

  • Protected the same people that the current government safety net does,
  • Involved no taxpayer dollars, and
  • Is anticipated to be immediately accretive to the acquiring company's earnings.

Could there have been a better resolution to an otherwise sticky problem? Perhaps, but at least this one didn't put taxpayers on the hook.

Bring on the successful failures!
In any healthy capital market, there's a risk/reward trade off. If you are putting your money at risk, you're doing so for the expectation of a reward. In general, the more risk you take, the more reward you can expect to receive if your risks turn out to be successful. For that market mechanism to function properly, the folks who take on risks that don't pan out must feel the financial pain of their failure.

In the capital market, having the participants feel the financial pain of their own failures serves some absolutely critical functions:

  • It entices people to make intelligent choices with their cash. If you're likely to lose your money if your investment doesn't succeed, you'll probably only be willing to invest in those ideas that have a legitimate shot of working.
  • It limits the collateral damage of a failed investment largely to those who were involved in the investment. Compare that to the tragedy of the commons that occurs with bailouts when one person gets the reward for a risk but all of us share the costs of its failure.
  • It gives the successful companies more "white space" to expand. After all, not only will their risks be rewarded, but their unsuccessful competitors will not be able to stick around long to cause more grief in the market.

Some banks should win
The spate of bank failures this year has been largely concentrated among companies that took on excessive risks compared with their true capital base. The two major classes of failures have been investment banks taking on extraordinary leverage to juice their returns and commercial banks betting big on subprime borrowers. Nearly every other bank has either done fine or had access to enough resources to cover their failures.

US Bancorp (NYSE: USB  ) , Wells Fargo (NYSE: WFC  ) , and BB&T (NYSE: BBT  ) are in much stronger positions now for having stayed largely out of subprime lending. They may have missed out of the phantom gains when subprime appeared to be working, but by recognizing the real risks and refusing to invest in it, they should be rewarded for their decisions.

Likewise, along with JPMorgan, Bank of America (NYSE: BAC  ) and Barclays (NYSE: BCS  ) have picked up the remains of many of the failures wrought by the subprime meltdown. Their astute capital management and prudent risk taking now allow them to reap the long run rewards the marketplace offers to those who don't bite off more than they can chew.

What future do you want?
In a functioning system that rewards success and punishes failure, in the long run, you get more banks like JPMorgan, Bank of America, US Bancorp, Wells Fargo, Barclays and BB&T. In a system where failures are rewarded with bailouts, you get more banks like Washington Mutual, Bear Stearns, IndyMac, and Lehman Brothers. For the good of your own pocketbook, the banking system, and the economy as a whole, let the market weed out its failures and reward its successes.

At the time of publication, Fool contributor Chuck Saletta owned shares of Bank of America and likely worthless stubs of what's left of Washington Mutual. While he's hurting from that loss, he'd much rather the market work its magic than have his investment bailed out for some short term gain in exchange for even worse long term pain. US Bancorp, JPMorgan Chase, BB & T, and Bank of America are Motley Fool Income Investor recommendations. The Fool's disclosure policy has never asked for a handout.


Read/Post Comments (18) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 30, 2008, at 4:45 PM, climba wrote:

    well, maybe WaMu will emerge out of bankruptcy as a REIT. They were not insolvent and it seems they filed bankuptcy voluntarily after being forced to sell their banking operations. Meanwhile they have 3 towers in Seattle and countless repoed properties.

  • Report this Comment On September 30, 2008, at 5:06 PM, jimCLX wrote:

    Sir,

    Let me make an analogy.

    Say, you had one million dollar in IRA and needed $10K to pay the last payment on your house. You couldn’t get money from the bank, and you couldn’t take money from your IRA because of regulation.

    The government came in and confiscated everything, you IRA, your house, because you failed to pay the bill, and gave all of it to the creditor free of charge. You are wiped out. Will you still say this is a beauty because it cost no taxpayer’s money, and did not create any noise?

    Further, if the government had discussion with the creditor to agree on this without informing you, what would you comment?

    Your discussion missed the major part of why this country is great: The private individuals and entities are protected from excessive government injury. Furthermore, the fairness is not just about the valuation, it involved the use of governmental power, apparent favoritism, and more. Forgive me, you article is one-sided and full of nonsense.

  • Report this Comment On September 30, 2008, at 5:28 PM, TMFBigFrog wrote:

    Hi jimCLX,

    .

    Thanks for your input, but I'm afraid your analogy is somewhat flawed. If you had a $1 million IRA and needed $10 thousand to pay off your house, you could easily get the cash to make the payment. Obviously, if you were 59 and a half or older, you could just take a standard withdrawal. Assuming you were under age 59 and a half, desperately needed the cash, and had no other source for it, you could still:

    * Take a hardship withdrawal from the IRA and get at your cash penalty-free.

    * Set up a SEPP plan that would let you withdraw far more than $10 thousand every year without facing a penalty.

    * Take a normal withdrawal and get your cash, but owe taxes and a 10% penalty.

    .

    Likewise, Washington Mutual had plenty of opportunities to raise capital or sell itself over the past year. It chose to take a limited, one time infusion and hope things got better. We can debate the reasons or the rationale behind that choice until we're blue in the face, but alternatives to a bankruptcy and collapse were available.

    .

    I agree with you that the method behind the JP Morgan purchase of Washington Mutual was quite scary for a lot of reasons, largely surrounding the excessive use of government power to benefit a favored company. Between Bear Stearns and Washington Mutual, JP Morgan is getting quite a reputation for using government fiat to get sweetheart deals on troubled companies.

    .

    That, however, is potentially a topic for another article. The limited real estate and topic scope available in any given article does force us to make choices in what we can include in any given piece.

    -

    Best regards,

    -Chuck

  • Report this Comment On September 30, 2008, at 6:07 PM, jimCLX wrote:

    Hi Chuck,

    Thanks for the reply. I think we do agree in principle on the issues regarding the final events surrounding its collapse.

    I would not dispute on what could have been done better. Granted, a lot of the decisions and handling of WM were grossly wrong on the management part in the past few years up to just two months before its collapse. That’s all history now.

    At this point, there are tens of thousands of WM shareholders being wiped out, many of them having huge savings tied to this in their retirement accounts. They are anxiously waiting for all the facts to come out. It is not clear how these facts are going to change the shareholder’s fate. I do think it is highly inappropriate at this point to use the word “beauty” to describe this event while thousands are suffering damages.

    Best Regards,

  • Report this Comment On September 30, 2008, at 7:00 PM, Calculated4Risks wrote:

    "tragedy for its depositors" Does this guy know what he's talking about? The only losers are the investors. Branches are still operating. All depositor's money is protected, at least for the time being.

  • Report this Comment On September 30, 2008, at 7:33 PM, retiredvstr wrote:

    The way this deal was done was, indeed slick, but disturbing. Allowing the acquiring bank to take the mispriced assets without assuming any responsibility for the debt is, in effect stealing from the bondholders. In one fell swoop, investment grade bonds lost nearly all of their value. Apparently this was legal because WaMu was a bank and once the government got involved, the shareholders and bondholders lost all of their rights...and money.

  • Report this Comment On September 30, 2008, at 10:55 PM, rphughes1 wrote:

    I'm 67 --Plan to retire in one year with far too little funds. I have 5000 shares of WM stock. Is there a way to get some of this investment back??? I even lost money on FNM. And after I sold it for 50 cents -- I now see its up to $1.50 Please help. Thanks Phil Hughes

  • Report this Comment On September 30, 2008, at 11:32 PM, rcarlin32 wrote:

    This whole deal stinks to high heaven. I know there are at least 4000 WAMU employees that busted their poseteriors for this company and believed in it. I'm wondering what happened to their 40l ks? I lost over $40000 in stock and bought most of my shares between 35 and 40 dollars. What was I thinking? Well the 6th lagrest bank in America couldn't fail. I know, stupid. I can survive my loss but what bothers me is the share holders were not even given a chance to decide the fate of its company. I hope somebody looks into what was really behind the decision to cut Wamu's head off. Personally I think the FDIC couldn't cover Wamus deposits so to avoid embarrasment worked a deal with JP. I don't know but with the govt. the way it functions now who knows the truth.

  • Report this Comment On October 01, 2008, at 12:58 AM, TMFBigFrog wrote:

    Hi Phil (rphughes1),

    .

    I wish my crystal ball were working and that I knew exactly where to invest to help you quickly recover the unfortunate losses you've seen in your investments. I also wish that my time machine were working so that I could go back in time and send a clear warning about the dangers that were going to hit.

    .

    When a company goes bankrupt, it's generally up to the bankruptcy judge and bondholders to determine if the stock holders get anything back. Quite often, stockholders lose everything.

    .

    In general, if you're close to retirement age, the rule of thumb is to start shifting your allocation more towards fixed income rather than all stock. The unfortunate recent catastrophes you've mentioned could be viewed as Exhibits A and B on why that's the case. If those troubled/bankrupt stocks were a large portion of your portfolio, there may be little you can do.

    .

    The best option may be to accept the losses, determine if they mean a retirement lifestyle change or a delay in reaching that goal, and make the best of the hand you've been dealt. I really do wish I had a better answer.

    .

    If you're concerned about your pending retirement, you may want to take a free 30 day trial of the Fool's "Rule Your Retirement" newsletter: http://www.fool.com/shop/newsletters/13/index.htm?source=irr... . Between the tools, the calculators, the very solid archive of old issues, and the community of retirement focused members and professionals, that newsletter has a lot of strong resources working for it.

    ..

    Best regards,

    -Chuck

  • Report this Comment On October 01, 2008, at 8:32 AM, jumpytrader wrote:

    Last night I responded too this article on your link for feed back. I had accidently sent half of it before finishing so I requested that you please send me a copy of both parts of my message back by E-Mail but I have not recieved anything back. So would you please respond. thank you.

  • Report this Comment On October 01, 2008, at 9:52 AM, danapokerfish wrote:

    Excellent article. It deserves to be sent to every member of Congress -- because if the bailout passes, we'll indeed get more WaMus and fewer BB&Ts -- and yet more disasters in the future that demand a massive fix, but "just until the crisis passes."

    This whole bailout boondoggle is right out of Atlas Shrugged.

  • Report this Comment On October 01, 2008, at 1:59 PM, Buffanatics666 wrote:

    Would somebody at the Motley Fool PLEASE tell me why they think USB was a conservative lender that "stayed largely out of sub-prime?". Again, WHERE did you get that information from? I bet you didn't even research what you said. If a bank started sub-prime lending one- two years after everyone else when would those losses start to show? Now. Watch Octobers earnings announcement. Why do you think USB is lobbying so hard to get the accounting rules changed regarding asset write downs?

    As a mortgage lender that used them I know they specialized in 100% financing, both stated and full documentation as low as 580 FICO score. They offered no equity refinances. No asset verification loans. So please tell me...WHERE do you get your information? October should be a wake up call. The only reason this stock is trading above ANY analyst recommendations is the Buffanatics of the world. USB is simply late to the implosion game in my opinion.

    But please...answer the question as to WHERE you got your information?

  • Report this Comment On October 01, 2008, at 8:30 PM, TMFBigFrog wrote:

    Hi Buffanatics666,

    .

    This article: http://www.fool.com/investing/dividends-income/2007/07/19/us... says that only 2.8% of US Bancorp's portfolio was subprime. That's where I got the information that it had stayed largely out of subprime. I know that the Fool's editors zealously look to assure factual misstatements stay out of the site.

    .

    -Chuck

    .

    PS to jumpytrader: The "feedback" link goes to the editors, not to the author. Given the amout of turbulence in the market and some of the controversial articles recently, I'm not sure they've had a chance to get through the feedback comments. If you have a question you would like me to answer, you can email me by clicking on the hyperlink of my name in the article above.

  • Report this Comment On October 01, 2008, at 11:42 PM, dfuey wrote:

    I'm sorry but your argument to me is ridiculous.

    This was fraud pure and simple. If you believe so heavily in the free markets why weren't Bear Stearns, Merril Lynch, and AIG allowed to fail with the WaMu's, and Lehman Brothers?

    Simply put, because the FDIC is in the back pockets of these large banks. As Steve Liesman put it on CNBC, "The FDIC is creating a club, and you're either in, or you're out."

    When the meltdown first happened our government should have decided to let all institutions fail confirming your argument of the free capital markets, or they should have helped them all succeed.

    Instead they chose arbitrarily who to help and who to destroy. This is not freedom of the capital markets, but manipulation of the grossest kind.

    I believe when I made the idiotic decision to vote for Bush a second term, I hired him to be President of the United States of America, not President of Iraq or Afghanistan. The money he chose to waste on those wars would have come in handy to keep all these companies afloat so we the American people would have been saved our investment in all these companies rather than being decimated as they were.

  • Report this Comment On October 02, 2008, at 3:07 AM, Buffanatics666 wrote:

    In response to Chuck: Thank you for your response to my post. Unfortunately, subprime has become a term that many investment “experts” do not understand (as witnessed by the closing caption of the very article you reference "US Bancorp and Washington Mutual are Motley Fool Income Investor recommendations"). Wamu would not fit the definition of "subprime" yet it is gone. Aurora Loans Services was the Alt-A lending branch of Lehman Brothers. It would not be considered subprime either, yet it killed Lehman. This is my point, only the people on my side of the fence understand what is really prime and subprime lending. In fact, I would bet that nobody can come up with a true definition of subprime. It is a nebulous term that nobody really understands and it changes based on the user's motivations. 2.8% exposure to subprime is the amount Emil Lee quotes for USB. Where does he get this figure? US Bank? More importantly, who's definition of subprime is Emil Lee quoting? I would bet it is again…USB’s. That intangible border between prime and subprime will make itself clear when USB starts to fail. They were heavily used by my industry to make loans other lenders would not. Subprime? Maybe not by my definition. Seriously, deeply Alt-A? Absolutlely. Alt-A lending was more than enough to kill Wamu and Lehman, and you can bet it is enough to kill off a regional bank like USB. US Bank was a year or two behind their peers in lowering their credit qualifications, but they were the LAST lender we had that was still doing 100% financing. They only stopped 4 months ago. Their lateness to the loss game has masked the true nature of this company. So you heard it here first: I am predicting a 2 billion dollar loss announcement at their next reporting (and it will get worse after that). I guess we will know if I am right or if I am an idiot on the 21st of October.

  • Report this Comment On October 02, 2008, at 4:39 AM, vballboy wrote:

    Nice clear vision for a heated situation where alot of people were running around screaming Chiken Little stuff..."Oh my goodness, the sky is falling.". Well, time will tell if the Fool is correct so let's wait a while...I'll put another comment in here in say, a month. By then we'll know if the market has crashed regardless of attempts by the politicians. The only question I always have is this...are the politicians generally honest or do they serve special interest and screw the voters/public.

    See you in a month. I wish us all luck that this doesn't turn out like 1929, or worse...cause that took a World War to fix.

  • Report this Comment On October 09, 2008, at 1:49 AM, jetnyc wrote:

    As a consumer's bank WaMu was pleasant and freindly. It didn't kill with fees and served its customers.

    Chase is not like that. High fees and low rates. I guess its off to a credit union for me.

    The consumer is worse off.

    Also, if the new tax rule permitting all of Wa Mu's losses to be taken had been in place (the one that allowed Wachovia to get a much higher offer from Wells Fargo), the WaMu shareholders would not have been completely wiped out. They would have gotten something. This makes the other down at heels banks look more interesting.

    The FDIC also increased its insurance limit which would have prevented the run on WaMu. JPMorgan got a great deal at the expense of WaMu shareholders. I think they are a good investment.

  • Report this Comment On November 20, 2008, at 5:49 PM, wldgrdnr wrote:

    Having invested in WAMU just weeks before the collapse, i cannot say that I am a happy camper these days, BUT I have been watching this closely and I think there is great potential for this stock to come back. WMI still has a lot of holdings, and they are far from broke. They filed Chaper 11, and with some luck they will come out of their re-org OK. It was a great loss to the company, no doubt, and what happened in my mind was unforgivable. The FDIC basically gave the company away. But WMI has hired some of the best attorneys out there, and have brought some great folks on board in the last few weeks. I, and lots of other stockholders are holding on, anticipating a better outcome than what a lot of folks are thinking. They still have billions of dollars in assets. The stock is certainly in the basement right now, but there is the potential for it to turn around, especially if the current investigation shows what a lot of stockholders are thinking...that there were some back room manuevering going on that enabled JPM to take advantage of the situation. It's not over til it's over, and it is along way from being over...the bankruptcy proceedings have only just begun. What heppened with WAMU certainly did a lot of damage to consumer confidence in the financials however. I don't think that will get better until the FDIC is held accountable for giving away a $309 Billion dollar bank for 1.9 Billion. In what world did that make any sense?

    JPM is being sued by Lehman brothers for freezing a 17 Billion dollar account that would have helped THEM avoid bankruptcy...

    They are being investigated for activity that may have caused or contributed to the collapse of Bear Stearns.

    JPM is being sued for manipulating other things in the banking world that caused banks to collapse andf then they swooped down and bought those banks.

    It's not over for them yet I think. I think JPM will be hit with more lawsuits soon--and i hope when it all comes out, JPM has to pay dearly for what they have done.

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