Government Arranges Deal With J.P. Morgan

By Binyamin Appelbaum

Washington Post Staff Writer

Friday, September 26, 2008; A01

Federal regulators last night seized the massive, troubled mortgage lender Washington Mutual in the largest bank failure in U.S. history, then immediately sold much of the company to J.P. Morgan Chase for $1.9 billion in a deal that will create the largest bank in the country.

The historic two-step was orchestrated by Sheila Bair, chairman of the Federal Deposit Insurance Corp., on terms that preserve Washington Mutual's deposits and avoid what could have been a huge drain on the insurance fund that protects deposits up to $100,000.

The fall of Washington Mutual, which was the country's largest savings and loans, expands once again the vast burned-over district at the heart of the financial industry. The federal government has seized mortgage-financiers Fannie Mae and Freddie Mac and insurance giant American International Group. The five largest independent investment banks are closed or have changed their business model. Most of the largest mortgage companies are closed or sold. This is the first time, however, that a large bank funded mostly by deposits has failed during the current crisis.

The sale furthers the consolidation of the U.S. financial industry, which is increasingly dominated by a few colossal banks with more than $1 trillion in assets, offering a vast range of services. J.P. Morgan will become the largest, surpassing Bank of America.

The willingness of J.P. Morgan to cover all of Washington Mutual's deposits narrowly averts a massive hit on the FDIC. Washington Mutual held $188 billion in deposits as of June, far more than any bank that has ever failed. Analysts estimated that a Washington Mutual failure could have soaked up half the money in the government insurance fund, forcing a huge increase in the premiums paid to the fund by other banks.

Bair said Washington Mutual lacked the cash to fund its business. Since Sept. 15, depositors pulled $16.7 billion from the bank, and the company's bond rating, a measure of its financial health, was slashed several times until Washington Mutual was ranked among the nation's most fragile companies.

Congress is currently debating a plan designed to relieve pressure on troubled banks by buying their mortgage-related investments. That could have helped Washington Mutual, but regulators decided that waiting any longer "was not a responsible decision to make," Bair said.

She said the FDIC had been planning to seize the company Friday night but acted yesterday because of concerns that media leaks would scare depositors. "This was an eroding situation," Bair said.

Washington Mutual, based in Seattle, made thousands of mortgage loans that its borrowers cannot repay. That has left it saddled with billions of dollars in bad debts. The company has posted losses for three straight quarters, including a loss of $3.3 billion for the most recent quarter, ending in June.

Last week, the company placed itself on the auction block, but bidders failed to materialize.

J.P. Morgan submitted the highest bid in an auction regulators held Wednesday night, buying Washington Mutual's 2,200 branches, its $135 billion in remaining deposits -- and its vast portfolio of troubled investments in mortgage-related securities. The deal does not affect depositors -- even those with deposits over the federal insured maximum -- or people with mortgage loans held by Washington Mutual.

J.P. Morgan said it would immediately write down $31 billion to reflect the deteriorated value of those investments and that it would add $3.6 billion to its own loss reserves. The company also said it would issue $8 billion in common stock this morning before the markets open, creating the larger capital cushion it needs to absorb the troubled company.

Chief executive Jamie Dimon said he was undeterred by Washington Mutual's financial problems and relatively unconcerned about the short-term struggles of the financial industry -- or the congressional debate about a possible bailout.

"We're getting franchises of this company for a long period of time," Dimon said on a conference call last night. "We didn't do this because we're guessing the economy is going to get a little bit better or going to get a little bit worse."

Washington Mutual had rejected a March offer of $8 a share from J.P. Morgan. The company's then-chief executive was subsequently fired.

With the acquisition, New York-based J.P. Morgan will gain a massive, long-desired presence on the West Coast. Neither company has branches in the Washington area. Washington Mutual's branches are concentrated in California, with large clusters in New York, Florida, Texas and the company's home state of Washington. J.P. Morgan has large numbers of branches in the Midwest, the Southwest and New York.

J.P. Morgan and Bank of America are emerging as the great winners in the current crisis. Funded by deposits and less involved in the business of securitizing loans, they are strong at a moment of weakness for erstwhile rivals. J.P. Morgan already has carried off the remnants of investment bank Bear Stearns, which collapsed in March. Bank of America has picked up Countrywide Financial and Merrill Lynch.

"Some in corporate leadership are now coming to Washington for help, others are coming to Washington to help," Bair said. She applauded J.P. Morgan's willingness "to put private capital at risk" and compared Dimon's actions to long-ago rescues orchestrated by the company's legendary namesake.

J.P. Morgan is not buying the holding company that owns the thrift, nor is it paying anything to shareholders in the company, who have essentially been wiped out, or those who have purchased its bonds. The $1.9 billion J.P. Morgan paid to the government will be paid out to the holding company's surviving creditors, but many of them will suffer large losses.

Washington Mutual's stock dropped 25 percent to $1.69 in trading yesterday, then fell another 73 percent to $0.45 in after-hours trading, reflecting the remaining value of what is now a shell company.

The failure marks the second time in recent months that a large bank has been seized by regulators before it was included in the FDIC's quarterly count of troubled institutions. IndyMac Bancorp, another large mortgage lender, was seized by regulators in July. That reflects the rapid pace of the financial crisis, but also has raised questions about the care with which regulators are scrutinizing trouble companies.

The Washington Mutual-J.P. Morgan deal is not subject to any of the reviews that normally attend a major bank merger.

"When you have a failing institution, you don't have time for that," Bair said.

Staff writer Zachary A. Goldfarb contributed to this report.