banking and the current fiscal crisis. Specifically it will discuss the failure of Washington Mutual (WaMu). The financial crisis in the United States is mounting, and it shows no signs of ending anytime soon. The American automakers are seeking a financial bailout, Congress passed a massive bailout for the banking and financial industry that seems to have stalled, businesses are failing at a high rate, and people are losing jobs at the highest rate in decades. The economy is in serious trouble, and the Washington Mutual failure, the largest bank failure in history, has helped make this crisis memorable and painful for many investors across the nation. Washington Mutual, a Seattle-based lender failed on September 26, 2008, when the FDIC seized the bank’s holdings and financial giant JP Morgan Chase took over the bank. It was a shocking element of the financial crisis, because it was such a major bank to fail, and it stemmed from several different distressing issues. Although Washington Mutual seemed like a very reliable West Coast bank to put one’s money in, Washington Mutual remains one of the largest banks in United States’ history to fail.
Up until 2007 or so, Washington Mutual seemed like a charmed financial institution. Founded in 1889 to help the city of Seattle recover after a devastating fire, the bank gradually grew to become America’s largest savings and loan, and a profitable Wall Street investment (Editors 1). It pioneered a new type of banking experience called “Occasio,” (which is Latin for “favorable opportunity), and attempted to change the entire face of banking. One author notes, “Entering an Occasio branch, the customer is first greeted by a ‘concierge’ who escorts them to the appropriate area. […] There are no desks to be found in the branch. Instead, bank representatives work at electronic ‘teller towers'” (Schmitt 157). It seemed that WaMu was at the top of the banking game and could never topple. That is what make WaMu’s fall so shocking to most Americans. It seemed to happen so quickly, and that one so large could fail so fast was doubly frightening. WaMu made some major mistakes that led the bank to fail, and sub-prime mortgage leading was a huge part in Washington Mutual’s downward spiral. Sub-prime mortgage lending began in 2004 as house prices soared throughout the country. The economy was strong, people were buying and selling homes at a rapid rate, and prices continued to climb out of reach of many Americans. The sub-prime mortgage game became a way for Americans to afford the home of their dreams with payments that seemed within reach – at least for a while. These low-interest rate mortgages used very low introductory interest rates to lure buyers in, and then, in a specific number of years, these variable-rate loans would mature, and so would the payments, leaving scores of buyers unable to pay their increased mortgages by 2007 and beyond. Unfortunately, a major part of WaMu’s investment portfolio included these sub-prime, adjustable-rate mortgages. Two Bloomberg reporters note, “Washington Mutual held $52.9 billion of the mortgages, also called option ARMs or negative amortization loans, on its books in the second quarter, with defaults doubling to $3.2 billion from the end of 2007, according to a filing with the U.S. Securities and Exchange Commission” (Ivy and Shen). Analysts believe that at least 45% of borrowers across the nation who hold these adjustable-rate mortgages will default, and WaMu’s borrowers were no exception, in fact, WaMu targeted areas where home sales were highest. They had about half of their ARMs in California, where the foreclosure rate was the second highest in the nation, and about 13% of their ARMs were in Florida, where foreclosures were the fourth highest in the nation (Ivy and Shen). It is easy to see how this practice came back to haunt WaMu.
Washington Mutual actually encouraged their mortgage brokers and underwriters to target individuals that could barely afford to pay the minimum monthly payment. They concentrated on lower-income borrowers, the perfect target for ARMs since in made monthly payments affordable for the first few years of the mortgage. The Editors of the “New York Times” note, “A strategy that had allowed for the bank’s phenomenal growth — focusing on lower-income borrowers — was now responsible for devastating losses” (Editors 1). Many of these borrowers did not fully understand the terms of the mortgages they signed, and did not understand that the payments would rise dramatically within a few years, (as much as 63%, or over $1,000 per month in many cases (Ivy and Shen). In addition, as housing prices began to fall in 2007, many of these sub-prime borrowers could not refinance their loans, because their house values had dropped so much that they owed more on the home than the house was now worth. It turned into a financial nightmare for WaMu, who had invested so heavily in this market in the beginning.
At the head of the WaMu phenomenon was Kerry Killinger, a 25-year employee of the institution who had led the company successfully for 18 years, and who stepped down as CEO on Sept. 9, just a few short weeks before the meltdown. In an early 2001 interview, Killinger said, “Our goal is to be the dominant mortgage lender in the U.S.,’ says Killinger. Within five years, he says, he hopes WaMu will hold a 15% market share in both origination and servicing” (Cocheo 22). They met that goal by acquiring mortgage firms and borrowing to acquire them, eventually building up the biggest mortgage holdings in the nation. However, these mortgage companies (and others) were often underwriting loans without fully checking out the borrowers. The Bloomberg reporters continue, “About 83% of the option ARMs issued from 2004 to 2007 were underwritten without full documentation of borrowers’ incomes, Fitch said” (Ivy and Shen). Thus, these borrowers were the most vulnerable to problems down the line with their ARMs, and yet, they were allowed to buy homes, often at inflated prices due to the rising house market, with incomes that could in no way manage the great rise in payments that would occur when the loans reset. In the meantime, these borrowers often borrowed more money on their homes through refinancing or second mortgages when values rose, creating even more debt to pay off as the homes’ values decreased. It was a shoddy way to lend money through mortgage institutions, and it too came back to haunt WaMu.
Another aspect of the current economic crisis helped cause WaMu to fail. As word began to spread that its’ mortgage holdings were so volatile, and rumors spread that it could actually fail, depositors began to remove their funds in mass numbers, the classic bank run. Two other writers note, “It was not just the largest failure in history. It was also extraordinarily quick and almost entirely painless from the government’s point-of-view. Its collapse was caused by an old phenomenon — a bank run — that occurred in a new way, driven largely by Internet rumors out of the public eye” (Adler and Hopkins). As the investors began to clamor for their money, Killinger hoped to sell the institution for a profit and to keep creditors at bay, but the bank had been too devalued by the bank run. Journalists Adler and Hopkins continue, “But it was already too late. By that time a run had begun, with deposit outflows eventually totaling $16.7 billion” (Adler and Hopkins). It was only a few days later that the FDIC stepped in, seized the bank, and JP Morgan Chase took over.
The customers of WaMu did not lose money, as their deposits were guaranteed up to $100,000 by the FDIC, and JP Morgan Chase agreed to guarantee the rest. However, bondholders and stockholders of the company were essentially wiped out, and they were the real victims in this failure (Editors 1) So were the mortgagees who lost their homes due to the aggressive lending practices of WaMu and its mortgage affiliates. They could not foresee the housing market falling as it did, and the number of foreclosures it would create, and so, they aggressively continued to pursue the market when they should have been cutting back. The top executives left the company, but they were not fired, in fact, Killinger retired, comfortably it would seem. The customers of the bank, especially those with mortgages, are the ones who really will suffer in the long-term. The bank will rebound, but those with foreclosed homes never got the chance for a bailout, and so, they lost everything, while the executives and leaders of the bank are not charged with any wrongdoing. Luckily, the American taxpayers did not suffer, either, because JP Morgan Chase financed the takeover and the continuing operations of the bank.
In conclusion, WaMu’s failure came about due to a number of reasons. They invested far too heavily in the sub-prime mortgage business, they targeted lower-income homebuyers who could not afford the payments when they inflated, they borrowed too much money to keep them afloat, they suffered a bank run, which reduced their cash flow, and they let their customers down in their failure. WaMu did not totally collapse, they were reinforced by JP Morgan Chase, who took them over and the FDIC, who insured deposits up to $100,000. However, they created a huge deficit for shareholders, who lost everything, and they illustrate that even the mightiest financial institutions can topple if they do not anticipate the market, do not act on it quickly, and do not thoroughly secure their loans and investments.
References
Adler, Joe, and Hopkins, Cheyenne. “FDIC’s ‘Big One’: Long Prelude Gave Way to a Sudden End.” American Banker, 29 Sept. 2008, Vol. 173, Issue 188.
Cocheo, Steve. “Kerry Killinger Builds His Dream Bank.” ABA Banking Journal 93.8 (2001): 22.
Editors. “Washington Mutual, Inc.” New York Times. 27 Sept. 2008. Business, 1.
Ivy, Bob and Shen, Linda. “Washington Mutual Hobbled by Increasing Defaults on Option ARMs.” Bloomberg.com. 15 Sept. 2008. 11 Dec. 2008. http://www.bloomberg.com/apps/news?pid=20601087&sid=aNSwdt57nTBI&refer=home
Schmitt, Bernd H. Customer Experience Management: A Revolutionary Approach to Connecting with Your Customers. Hoboken, NJ: John Wiley & Sons, 2003.
