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The WaMu Speed Bankruptcy
The Washington Mutual "speed bankruptcy" seems like a good model for the rest of the industry. The FDIC took over the bank, wiped out the shareholders, and immediately auctioned it off to JP Morgan who paid $1.9 billion. Depositors are secure.
Notice that to do the deal, JP Morgan raised $10 billion in the equity markets and their shares rose. Moreover, the issue was oversubscribed so they may go back for more. All this illustrates that at least some of the substitute bridges from savers to investors that I have talked about continue to work (on the latter point see also Arnold Kling and Steve Landsburg).
Hat tip to Garrett Jones.
Posted by Alex Tabarrok on September 26, 2008 at 07:34 PM in Current Affairs | Permalink
Comments
It's easier to pull off things like this when the regulator is only or mostly a single entity. OTS has been shopping WaMu for weeks, look at all the rumors.
Posted by: nelsonal at Sep 26, 2008 8:09:36 PM
Yes... but... but... this doesn't prove anything.
JP Morgan is in the same position as Buffett with Goldman Sachs. They're operating under the assumption that there will be some form of major government intervention (whether Paulson's bailout or another form) that will keep the system from imploding. WaMu's retail network and Goldman Sachs market position were able to attract major players who were willing to bet on a forthcoming bailout. We shouldn't leap to the conclusion that other private equity is going to come to the rescue of every Tom, Dick and Harry that's in trouble.
FDIC receiverships like WaMu -- with buyers that pick up the deposits and operations to assure continuity of business -- will be a significant piece of the bailout process.
The bailout isn't a replacement for FDIC managing these sorts of takeovers that wipe out shareholders and lots of creditors. The bailout -- which is mostly a backdoor recapitalization because the toxic assets will be bought a a higher price than what would be achieved in a market sale -- is supposed to make the number and scope of bank failures smaller and keep the survivors functioning.
Dodd's revised Paulson plan -- which last I saw was up to about 100 pages of legislation -- will give Treasury a series of options, not just Bernanke's "reverse auction" to discover a value-to-maturity price, and not just toxic mortgage-related assets but any asset class that needs help. The flexibility on asset classes helps avoid future contagion problems.
The flexibility on options allows the program to operate more like a typical bank rescue program. If they're right that it's mostly a liquidity problem, then the asset purchases will be the major part of their activity. But as weaknesses in the system show up, they can address capitalization problems as well.
They will triage the institutions, send the dying off to the FDIC, use the NYFed/FDIC and part of the $700 billion to manage sale/reorg of the ones that are wobbly but can survive with help, and buy assets in Bernanke's "reverse auction" scheme to provide liquidity to institutions that are otherwise pretty healthy.
I'm not suggesting private capital won't be vital. It will be an important element in each of the options Treasury has. Private capital will eventually have to pick up the distressed assets Treasury or FDIC acquires. Private capital will be part of any sale or reorg of a a wobbly but survivable firm. And the healthier instituitions will all need additional private capital -- beyond whatever benefits they receive from Treasury's asset purchases -- to delever their balance sheets.
But private capital is only going to come in in a big way if the markets think the systemic risks are in the process of being addressed by the government.
Posted by: nadezhda at Sep 26, 2008 8:10:32 PM
That is what the FDIC and OTS always do with seized banks - not really a novel playbook.
Posted by: Chris at Sep 26, 2008 8:19:28 PM
I'm starting to feel pretty confident the bailout is a bad idea. You can't magically make risk go away. It will still exist, we'll maybe get more inflation, and money will go into goverment paper instead of capital investment.
The reason the value is low isn't a lack of cash. It's because default risk has gone up because cost of living has gone up, asset values have gone down and incomes have remained flat or declined. That big house doesn't look worth it when you can't save or eat the foods you're used to.
People need to realize there is no such this as a risk free return. If they want to make money, they need to take a chance and invest in people doing things. Money needs to come out of commodities and go into people and capital. I don't see the bailout doing that. I think it will do the opposite.
Posted by: aaron at Sep 26, 2008 8:26:32 PM
This WaMu fiasco is inexcusable. FDIC is chomping at the bit to undermine investors at every turn under cover of night like Batman. This heavy-handed closeout of both shareholders and bondholders (both of which I was) is unprecendented. I believed in WaMu and the free market. If WaMu had been allowed to maintain through 2009, it and many of us would have flourished. I think time will show FDIC acted way too soon, motivated by a desire not to have to pay out of pocket to reimburse deposits, and the rest of us can go to hell. More to the point, this quick-fire marginalization of institutions by word of mouth has got to stop. If media would shut its mouth a bit, we wouldn't have had to endure the run on deposits that freaked FDIC out in the first place. Yuck!
Posted by: MrFuious at Sep 26, 2008 10:29:19 PM
MrFuious,
The smart money has been bailing on the banking sector for well over a year now, and speaking vociferously (and in hindsight very accurately) about the problems there as security prices fell and fell and fell and fell. . .
You had plenty of opportunity to get out of WaMu stock and bonds over last year and yet you chose to stay invested. I'm sorry for your losses, but you need to take responsibility for them and not blame them on the FDIC and the media. . .
Posted by: Matthew C. at Sep 26, 2008 10:45:52 PM
If WaMu had been allowed to maintain through 2009, it and many of us would have flourished.
Have you taken a serious look at WaMu's loan portfolio? The continued their reckless lending throughout 2007 when every other bank had pulled back. They would still be dealing with toxic loans in 2009, while every other bank had cleared them out by then. They loaned $700K for a crap shack in Jacumba, CA on the Mexican border hours east of SD in 2007. If they don't fail, then it signals to every bank "don't worry, make all the toxic loans you want because we won't do anything about it and we'll bail you out in the end."
Posted by: JordanT at Sep 26, 2008 11:19:05 PM
Proof that mark to market accounting is not the culprit -- the market simply needs to operate freely to find the market price. It is there.
Posted by: SheetWise at Sep 27, 2008 12:40:27 AM
Mark-to-market alone isn't the problem. Mark-to-market financed by short term debt is the problem. It's all one big margin call.
Posted by: David at Sep 27, 2008 12:50:49 AM
The speed liquidation was impressive indeed. Amazing how easy it is to sell a bank that you don't own. The fact that this entire action was done without consulting with the board of directors and executive management sets a pretty frightening precendent. "please invest in our capital markets" (only we may selectively nationalize them overnight) Didn't work too well for cuba. Yes their loan portfolio was lousy - but look at JPM's own materials for the acquisition - they see WaMu alone producing $12 billion in capital over the next several years. Highly profitable on it's own? Maybe not - but viable based on assets - most likely. This was a liquidity sparked run that freaked out the FDIC.
WaMu walked up to the edge, but they were pushed over it prematurely. Beware of increasing government bailouts because it not only excuses but necessitates this behaviour as the taxpayers are seen to have fiduciary responsibility in conflict with the capital markets.
Posted by: mike at Sep 27, 2008 12:59:25 AM
I don't understand. If WaMu was worth $1.9 billion, why didn't it auction itself off and distribute the $1.9 B to its shareholders?
Why does the FDIC get the money?
Posted by: Phil at Sep 27, 2008 1:10:27 AM
Phil: It is a bit weird that FDIC gets that money instead of the bond- and share-holders. But considering it represents about $1/share, it wouldn't make much difference to any shareholder who bought in more than a week ago.
Posted by: David Wright at Sep 27, 2008 1:25:50 AM
I doubt a bank could auction itself off publicly without causing a run. And it seems the secret auction was triggered by deposits flying out of WaMu. $17B in nine days.
I don't think it's weird that FDIC gets that money. First of all, it's not equity.
I don't think the role of greed and ego can be overstated. If WaMu had made the right offer to the right bank earlier on they would have been bought. Instead management got a sucker to give them $8B in April so they could keep control. Now they're all toast.
Posted by: David at Sep 27, 2008 2:20:28 AM
I understand that the FDIC is acting as a receiver and will distribute the $1.9 billion it received from JPM to the unsecured creditors whose claim totals $14.6 billion.
According to
http://us.ft.com/ftgateway/superpage.ft?news_id=fto092620081441572857
Posted by: sort_of_knowledgeable at Sep 27, 2008 4:54:56 AM
From a bit of spam that's made its way to my inbox... If there must be a bailout why not bailout every person in the country: $700B/300M people = $233,333/person. Obvious problem: causes rampant inflation. Solutions: give less ("Well golly Beaver, that doesn't sound so bad."), simultaneously create a savings incentive (a la what you've previously proposed, but more so: "You can have $10,000 cash or $100,000 in your IRA.").
Any dislike for this proposal on uncertainty grounds (i.e., we don't know how much to give to avoid massive inflation but also stop the crisis) needs to confront the parallel uncertainty in the problem itself. Likewise, wealth transfer critiques are faced with the problem that any bailout of any kind amounts to a wealth transfer from tax-payers to the beneficiaries.
It all seems rather glib, but seriously... why not?
Posted by: Angus Hendrick at Sep 27, 2008 5:06:45 AM
Angus, may it's a decimal point/comma conversion problem, but 700B/300M is two thousand dollars and change, not two hundred or two hundred thousand.
Posted by: ogmb at Sep 27, 2008 7:12:07 AM
I don't understand. If WaMu was worth $1.9 billion, why didn't it auction itself off and distribute the $1.9 B to its shareholders?
Why does the FDIC get the money?
+11111111
Posted by: Hikaye at Sep 27, 2008 7:20:22 AM
Hikaye, you realize that there's a long line of people WaMu owes money to and common shareholders always come last, right? That's how it works.
Posted by: David at Sep 27, 2008 10:15:23 AM
I fully agree that speculation is risky, but I think it's unacceptable to assert that the writing was so clearly on the wall for WaMu. Only so for those who stayed away, which in the grand scheme is an action which contributes to the demise (a self-fulfilling prophecy). Ny neighbor for example has held all of his investment capital in money markets for almost two years -- there's just something almost un-American about it. Anyway, FDIC seizure is clearly not something anyone expects, or we wouldn't see such huge write-downs from companies with more to lose than me. If Americans hadn't foolishly started withdrawing assets from branches in the past few weeks (had they all forgotten that deposits are insured?) I think the picture would be very different.
More to the point, we should indeed be appalled at both the discounted price that JP was allowed to pay. Yes, WaMu should have sold earlier in the year, but at that time the entire compnay would have acquired (toxic assets and all for 4x what was just paid). No, I hold FDIC entirely to blame for hosing the wrong people in this case. Bondholders especially should never be completely overlooked.
So what happens to the "toxic assets" now? I'm not one of those people who believes that they are valueless. Does a holding company continue to exist that could conceivably recoup something over the next few decades? I mean, the collateral still physically exists... Why shouldn't debt holders get a stake in an entity which owns that property?
Posted by: MrFurious at Sep 27, 2008 12:34:47 PM
What the hell? What's with all the polyannas in this thread who claim not to believe that WaMu was already seriously hosed? If you invest any serious money in this company, you SHOULD have known about the huge problems with their Alt-A portfolio; their concentration in the sinking markets in Florida and California; their poor lending standards; and their very large percentage of non-performing assets.
You might also have wondered why their stock declined from the high 30's into the low single digits over the course of a year. Or, why their credit was rated as junk status (with one of the raters setting out a very clear opinion that the company was insolvent). Or, why the CDS prices showed an overwhelmingly high probability of default. If you missed these signs, you are simply an idiot and you do not deserve the taxpayer's help.
The first thing JPM did when they assumed WaMu's assets was to write them down by $31b. They also released a shareholder presentation showing that there's a good chance they'll have to write it down even further. This is the REAL price JPM paid to acquire WM's business.
The question we should REALLY be asking is: why so much forebearance upon these reckless banks? Why are they allowed to stay open so long, gambling with taxpayer money (in the form of FDIC guarantees + any future bailout idiocy to spew forth from congress)? The FDIC only shut down WM because a bank run forced the issue. This seems to be a pattern with all of their closures this year, each of which were so deeply in the red it makes one wonder what in the hell the FDIC is waiting for? I don't think this was so common during the S&L crisis, when S&L's were usually closed with much less red ink.
The worrying thing is, there are probably dozens of banks - thankfully, all smaller than WM - that are in MUCH worse shape than WM is, and they have no realistic hope of recovery. The only thing keeping them open is a taxpayer-backed guarantee.
Posted by: mr commenter person at Sep 27, 2008 4:42:48 PM
I should add that the "dozens" of bad banks I refer to are only a small minority of nearly 8,500 US banks that are mostly in good condition. Now, maybe it's really "hundreds" of banks that are bad, but I for one think it's very worrying for American capitalism that our system lets savers' capital stay tied up in the bad ones, like WaMu, whereas the other 90% of banks are handicapped by their conservative, low-yield investments. Another worrying fact is that any bailout will almost certainly bring a huge benefit to the bad banks, while bringing little or no benefit to the ones that were cautious. We as a country are systematically allocating our capital toward institutions that gamble away taxpayer money, and I fear we're also leaving behind the institutions that take a conservative, long-term view.
Posted by: mr commenter person at Sep 27, 2008 4:48:48 PM
McFurious: So what happens to the "toxic assets" now? I'm not one of those people who believes that they are valueless.
So you should have sold your WaMu stocks and bonds and invested in the mortgage paper directly. The ratio of people who say the paper is quite valuable to those actually buying it at today's high discounts is amazingly high.
Posted by: nick at Sep 27, 2008 7:02:52 PM
Nick: AFAIK, there is no way for retail investors to buy MBSs (e.g. via an ETF or a mutual fund that pays the yield as dividends). It would be interesting to see what would happen if they could. Please correct me if I'm wrong about this.
Posted by: David Wright at Sep 27, 2008 8:24:29 PM
Certainly, mr commentator person, upon reflection you might consider retracting "idiot." As I said, there are tons of major investors who are similarly gobsmacked by the swift action of FDIC. Junk bond ratings don't just "imply" FDIC seizure, nor does a low stock price.
I don't know what you define as "serious money" or what I "ought to have known" about the details of WaMu's portfolios. Not as much is known to private investors as may be known within the industry. I'm just a humble American, a "Pollyanna" if you will, trying to eke out a future. I hold a belief shared by many that the necessary and proper way to rescue an ailing business with undervalued assets is to find enough people who agree to see it through for a profit, not to assume control like the mafia, tearing up IOUs, and doing we still don't know what with all of its holdings.
There's no question in anyone's mind that Killinger didn't see the forest for the trees, but don't forget that our government created and later mandated that these very same toxic assets be represented in the portfolios of the entire financial sector. From where I sit, to bail out the government's own toxic corporations (Mac/Mae) while hanging the privates sector out to dry smacks of conspiracy.
Investors should be outraged, asking questions, and finding solutions. We oughtn't be rubbing salt on each other's wounds with "I told you so's" and rhetoric about the recklessness of capitalism.
Posted by: MrFurious at Sep 28, 2008 12:03:25 AM
MANY people could have told you so. Stop whining.
From now on, don't invest in insolvent companies without understanding the risks.
Posted by: mr commenter person at Sep 28, 2008 7:35:34 AM
