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WaMu, bank runs, zombies and Bair

The story of Washington Mutual Inc. is a horror story for bank executives and one that just won't die. Zombie WaMu has sparked tons of class-action lawsuits, and now at least one of those lawsuits will be heading to trial. Because WaMu shareholders would not bury the bank, the Pudget Sound Business Journal dug deep into the story behind the bank's failure. The paper discovered the bank failed after two bank runs occurred last year, executives may have misled shareholders in order to build capital, and the Federal Deposit Insurance Corp.'s Sheila Bair may have been pitching the bank as a distressed asset sale as bank executives were looking for a buyer.

The failure of WaMu was ultimately due to a lack of consumer confidence in the bank. The first bank run was actually right after the collapse of IndyMac in July 2008. The bank suffered $9.4 billion in withdrawals and was not reported to the shareholders or the public because it was able to build back that capital by "luring customers through a new certificate of deposit that offered 5 percent interest, a strong return at the time." The loans were sold cheap, and another concern for consumers and even employees that worked at the bank were ARMs, pay-option adjustable-rate mortgages, according to a report by the Pudget Sound Business Journal.

But by July 2007, across the industry, big investors became alarmed by how many borrowers were not paying off their loans, and stopped buying packages of option ARMs.

The number of bad loans on WaMu's books soared, scaring big depositors whose accounts weren't fully insured.

When WaMu went under, the bad option ARM loans in its portfolio had nearly quintupled in the last 12 months to $3.2 billion.

The second run occurred at the end of September after Moody's Investors Service (NYSE:MCO) downgraded WaMu's debt to junk status. WaMu customers pulled $600 million out of the bank that day. In the next three days, customers pulled another $2.3 billion. Customers pulled out another $2.4 billion on the day the FDIC regulators came knocking.

After the Moody's downgrade, CEO Alan Fishman said he had approached Wells Fargo & Co. (NYSE:WFC), J.P. Morgan Chase & Co. (NYSE:JPM) and Citigroup Inc. (NYSE:C). Fishman was trying to sell the bank for $8 billion by the end of September, the deadline regulators had given him so WaMu would not be listed as a problem bank.

But the banks were one step ahead and knew WaMu could probably be purchased as a distressed asset through the FDIC. What ever happened next between Bair and the banks is unknown, but the report basically says the FDIC undercut the WaMu's sale process:

Bair apparently told Fishman another intriguing piece of information: She said more than one bank had called the FDIC to ask whether there would be an opportunity to buy WaMu as a distressed asset, according to people familiar with the meeting. In other words, was the government planning to seize and sell the bank? If so, potential buyers would rather wait, for the price was sure to be lower in a government sale.

What Bair might have said to the banks remains unclear, and is likely to be a focus of at least some of the ongoing investigations. Bair declined repeated requests to be interviewed about her role and decisions. The FDIC released Bair's emails regarding WaMu. They were almost completely redacted. Within days, JPMorgan Chase, Wells Fargo and Citibank stopped poring over WaMu's books.

Days later the bank was shut down, and assets were given over to J.P. Morgan. The government's action wiped out shareholders, but the FDIC's deposit fund was unscathed.

The story that the Pudget Sound Business Journal uncovers prompts many questions:

Why was there a run on the bank by consumers whose funds would have been insured by the FDIC?
Why were shareholders never notified of the first bank run?
Did executives misrepresent the lending standards of the bank to build capital?
Did Bair auction off WaMu to save the deposit fund?
Did this interfere with the executives sale of WaMu?
These will likely be explored when a class-action suit against WaMu executives heading to trial in May 2011. The lawsuit alleges the executives committed securities fraud by misrepresenting the failed thrift's lending standards and practices; not disclosing practices such as pressuring appraisers to inflate home values; and filing false and misleading financial reports with the SEC. "The plaintiffs contend that the bank's standards were relaxed to meet consumer demand and bolster the company's stock price,"according to AMLaw Litigation Daily. The report says defendants in the case are:

Simpson Thacher & Bartlett attorneys Barry Ostrager and Rob Pfister for former WaMu officers; Ronald Berenstain of Perkins Coie for former WaMu outside directors; Barry Kaplan of Wilson Sonsini Goodrich & Rosati for former WaMu CEO Kerry Killinger; Peter Wald of Latham & Watkins for Deloitte; and Jonathan Dickey of Gibson Dunn & Crutcher for the underwriters.

The trial also is likely to uncover more information that could prompt even more lawsuits. So, in effect, the failure of WaMu could haunt the banking industry for years. - Maria Woehr

http://www.thedeal.com/dealscape/2009/10/wamu_failed_because_of_two_ban.php