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When Washington Mutual (OTC BB: WAMUQ.PK) filed for bankruptcy protection, it originally listed $32.9 billion in assets and $8.2 billion in debts. That's hardly a balance sheet that would force a company to seek court supervision in ordinary times. And even in today's extraordinary times, with that kind of apparent strength, there's no logical reason why the company wouldn't have been able to raise more money.

General Electric (NYSE: GE  ) , for instance, was just this week able to place commercial paper at 2.05% interest. That was even before Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) made its multibillion-dollar investment. Even amidst this crisis, people are willing to finance companies with solid balance sheets and decent long-run prospects.

Risk of complete failure
There was one critical difference between General Electric and Washington Mutual, however. Nobody believed that General Electric was teetering on the edge of collapse, whereas Washington Mutual had been viewed as a serious risk for quite some time. Even so, in a bankruptcy, bondholders should have first dibs on a company's remaining assets. There ought to have been some financing scheme that attracted investors.

But no investors showed up in time for the company to avoid catastrophe. Instead, Washington Mutual wound up seized by the government and had its banking business immediately sold to JPMorgan Chase (NYSE: JPM  ) . While I initially thought that the JPMorgan deal was a decent way to handle Washington Mutual's collapse, I've recently been pointed to data that suggests otherwise.

After all, it wasn't until after the Washington Mutual seizure on Sept. 24 that the capital market really stopped working. As fellow Fools David Forrest and Bill Mann recently pointed out, the TED spread has skyrocketed since then, indicating a potential breakdown in the financing market. They point the blame on the failure of the bailout bill to pass Congress on its first go-round.

Bad medicine
While their explanation may seem reasonable, the method of Washington Mutual's demise probably had quite a bit to do with that market breakdown. Astonishingly, claims by debt holders are not included as part of the JPMorgan "deal."

In other words, Washington Mutual bondholders don't have the bankruptcy claim on the company's assets that they thought they did. The government just appropriated those assets and handed them to a better politically connected company. What's left of the old Washington Mutual may have some assets that followed it into bankruptcy, but even those assets aren't quite what they originally seemed. In a recent SEC filing, Washington Mutual disclosed:

In its chapter 11 petition, the Company reported that the amount of assets reflected on its books and records was $32,896,605,516. However, this amount includes the Company’s common stock interest in Washington Mutual Bank, which is currently in receivership and the assets of which have reportedly been transferred to JPMorgan Chase & Co. or an affiliate. The FDIC, which was appointed the receiver for the bank, indicates on its website that it does not anticipate that there will be any recovery to the Company for that common stock interest. [Emphasis added]

So not only have they lost their dibs on the company's assets, but the bond holders aren't even getting as much as they originally thought they'd be entitled to as part of this screwball process. That hurts, a lot. It even hurts far beyond the specific case of Washington Mutual.

Would you loan them money?
The pecking order of claims against a company's assets is absolutely essential to the functioning of the capital finance market. Without it, interest rates would naturally be higher for even the strongest of firms, as an important safety valve for bondholders would be missing. For companies at even the slightest risk of failing, short-circuiting that pecking order would make financing completely out of reach, even in a healthy market.

AAA-rated companies such as Microsoft (Nasdaq: MSFT  ) , Johnson & Johnson (NYSE: JNJ  ) , ExxonMobil (NYSE: XOM  ) , and ADP (NYSE: ADP  ) will always be able to borrow money. They may not even feel the few basis points of additional risk that'll be priced into their debt as a result. For lesser companies, however, the loss of that pecking order could very likely be the difference between survival and bankruptcy.

Be careful what you ask for
By trampling over the rights of Washington Mutual bondholders, the government set an extremely dangerous precedent that is already reverberating throughout the capital markets. If Congress really wants to help the country recover, it must first rein in the tyrants at the FDIC that just destroyed the pecking order so critical to the functioning of the markets.

Without that urgent fix, no liquidity injection or other bailout, no matter how big or well-intentioned, will get the markets working again.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric, Johnson & Johnson, and Microsoft, as well as some likely worthless stubs of Washington Mutual. JPMorgan Chase and Johnson & Johnson are Motley Fool Income Investor picks. Microsoft and Berkshire Hathaway are Motley Fool Inside Value selections. Berkshire Hathaway is a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire Hathaway and has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (14)

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 October 03, 2008, at 8:33 AM, StocksBuyorSell wrote:

    I agree with what you said above with the exception of the last paragraph where you say....

    AAA-rated companies such as Microsoft (Nasdaq: MSFT), Johnson & Johnson (NYSE: JNJ), ExxonMobil (NYSE: XOM), and ADP (NYSE: ADP) will always be able to borrow money.

    That is not necessarily the case, because if the banking system collapses, there will not be much liquidity for any company - even the good ones. And even if there is, the economy will still tank because all the other business out there will not have access to capital which means that even Microsoft and ADP will be badly hurt. The bottom line is no company is immune - even Steve Balmer said that in a recent quote.

  • Report this Comment On October 03, 2008, at 2:34 PM, jdlech wrote:

    Well, they saved the banks. But....

    We're buying up those bad MBSs from whom? Investment banks and firms?

    At what leverage do they operate?

    Where do they invest?

    We can expect huge growth in the stock market in the coming months as they turn these billions into trillions and dump them on the market. From there, profit taking will make it slosh onto Main Street.

    Can you say hyperinflation?

  • Report this Comment On October 10, 2008, at 9:58 AM, BeboLindo wrote:

    A couple of questions:

    I need a clearer picture of how the WaMu collapse is being handled. If the conclusions of this article are correct, the world's financial markets are in DEEP doo-doo. Can anyone provide links or references to a more detailed synopsis?

    Also, does anyone know what culpability Moody's has for its "error" discovered in early 2007 and not publicized for what, over a year, in its computer code that gave AAA ratings to certain subprime securitizations? I am wondering how much of the world bought toxic "Weapons of Financial Mass Destruction" (W.Buffett's term) based on such faulty information. I should think that could be outright criminal fraud.

    The "bailout" bill that passed apparently had some NICE wording to the effect that "at the discretion of the Secretary of the Treasury" other methods (read stock capital injection, (aka warrants for huge capital stakes a la Fannie, Freddie, etc.) I was heartened to hear on yesterday's news that the Sec. is "considering" such actions, right out loud. HOORAY! This is MUCH better market discipline than "bring our your dead [unpriceable assets for the taxpayers to buy]". There is also renewed talk of forcing CDSs (Credit Default Swaps] onto a transparent exchange. To those who say "can't be done, CDSs are all unique, unlike gold, which is all the same" I ask, how is it done with oil futures? Oil from different sources is readily handled despite WIDE differences in quality and useability.

    Where in the press (TMFor othewise) can one find more sound info. on the above? There is such a cacophony of noise out there! And most is just that, noise without meaning.

  • Report this Comment On October 10, 2008, at 10:16 AM, BeboLindo wrote:

    Let me add, if Chuck Saletta is right, if the screwing of the bondholders is accurate, I agree this undermines the trust basis of our ENTIRE financial system. If the conclusions of this article are correct, does that point to criminal malfeasance by the tyrants? [And cronyism?]


    Is it legal?


    And if not, what recourse is there?


    This needs lots of public attention ! !

    Thanks for bring it up Chuck ! Is this the only place this is being publicized? How can it be brought to wider attention?

  • Report this Comment On October 15, 2008, at 10:01 PM, TMFBigFrog wrote:

    Hi BeboLindo,


    Here is the key reference document I used for the "claims by debt holders are not included" line:


    If you want to see any of my other reference materials, please email me via the link to my name (highlighted above, near the end of the article).


    Best regards,


  • Report this Comment On February 21, 2009, at 6:23 PM, ftwhat wrote:

    This ( is the only place discussing the significance of the wipeout of WMB debtholders. Why is that?

  • Report this Comment On February 22, 2009, at 5:28 PM, W3Research1 wrote:

    WAMUQ: Washington Mutual - WaMu Investors Demand Hearing, Investigation & Reversal of Washington Mutual Seizure ...

    WAMUQ: Shareholder Information ...

    WAMUQ'D The Movie:

    Excellent Video on What Really Happened ...

    WaMu Truth: JP Morgan and FDIC Collusion Behind WaMu Seizure:

    Wall Street Journal Washington Mutual Media Coverage ...

  • Report this Comment On February 22, 2009, at 5:31 PM, W3Research1 wrote:

    WAMUQ: Washington Mutual - WaMu Investors Demand Hearing, Investigation & Reversal of Washington Mutual Seizure ...

    WAMUQ: Shareholder Information ...

    WAMUQ'D The Movie:

    Excellent Video on What Really Happened ...

    WaMu Truth: JP Morgan and FDIC Collusion Behind WaMu Seizure:

    Wall Street Journal Washington Mutual Media Coverage ...

  • Report this Comment On February 26, 2009, at 11:36 PM, p1at0 wrote:

    Are you kidding? WaMu was beyond broke, regardless of whatever BS they put in their filing. They were sitting on top of more than $50 billion-with-a-B in Option ARM loans alone. How many of those loans do you suppose were made to un-creditworthy borrowers buying insanely overpriced real estate in bubble states like CA, FL, and NV? Probably close to 100%. Then they had all those seconds plus that gem of a subprime credit card company, Providian (how much delinquency do you suppose there is in *that* portfolio today?)

    Face it -- Kerry Killinger took insane risks with other people's money and drove the company into the ground. Bondholders were idiots for letting it happen right before their eyes, and in the end they got exactly what they would have gotten if WaMu went into liquidation -- squat.

  • Report this Comment On April 06, 2009, at 5:02 PM, bondnut wrote:

    I got 68 cents on the dollar when I sold my senior wamu bond after bankruptcy. It was trading for 60 cents right before the bankruptcy. Big deal. I bought some Amex bonds with same maturity and interest rate at 75 cents on a dollar to replace the bond. Lots of good companies in business were trading around 68 cents when I sold my bankrupt wamu bond. I doubt in bankruptcy or out it would have matter. Heck my citi bonds dipped as low as 45 cents back in March which is 23 cents lower than my bankrupt wamu bonds were trading.

  • Report this Comment On September 06, 2009, at 12:41 PM, HROLLER30 wrote:

    Wamu TRUTH...Please Help...Wamu TRUTH...


    JPMorgan admits that the FDIC took over a solvent bank in one of the latest court documents...

    Please, take some time and read these documents. They are a bit long but well worth the read. Don't you wonder why the main stream media doesn't mention the suppose "failure" of the largest financial institution in America? Wamu was a 100+ year old company.....Here is a link to all documents filed through the BK Court;

    Jamie Dimon planted "moles" in Wamu??? JPMorgan committed corporate fraud???

    Wamu's claims against JPMorgan/Chase;

    I'm also enclosing another link that quotes Judge Hughes from a case against the FDIC that was wrapped up on August 24, 2005;

    "The record shows that the swap was the only reason for this suit. It also shows that the FDIC knew that it had no factual or legal basis for its claims, and that its cases here and in Washington were shams."

    As usual, Judge Hughes is acerbic in his opinion regarding the FDIC's conduct, noting in particular that FDIC officials "lied about it all under oath" and they "discarded the mantle of the American Republic for the cloak of a secret society of extortionists."

    "It's hard to find a word that captures the essence of the FDIC's bringing this action. Irresponsible is close. Arbitrary, dishonest, exploitative, extortionate, and abusive all fit."

    Judge Hughes concluded that Hurwitz and Maxxam "will recover their costs because the record reveals corrupt individuals within a corrupt agency with corrupt influences on it, bringing this litigation."

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