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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.
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.