The largest bank failure in the history of the United States occurred today as the FDIC seized Washington Mutual, a northwest regional savings and loan. The Seattle based bank had $310 billion in assets, but was under severe liquidity pressure due to the credit squeeze gripping international capital markets. The previous largest failure was Continental Illinois National Bank with assets of $40 billion in 1984. Because JP Morgan-Chase immediately bought the banks assets for a mere $1.9 billion, the FDIC will not have to expend money from its insurance fund which it had to do when it seized IndyMac bank earlier{7/15/08}. JP Morgan will write down WaMu's bad mortgage loan portfolio by about $31 billion. WaMu got into trouble in 2006 when its loan department reported a loss of $48 million due to its sub-prime lending practices, notably "Option ARMs" which featured very low introductory payments and the option to defer loan interest, principal or both payments until later years.
Many economists doubt that the federal government's rush to put a money band aid on Wall Street will advert more financial failures or even a significant recession. A ranking Republican came out of White House conference Thursday and held up what he said was a five page list of economists opposing the rescue plan. Kenneth Rogoff, a Harvard economist and former IMF official whom I quoted previously, thinks some failures are necessary to clear out weak institutions as the industry undergoes a fundamental shift. The global financial system nearly melted down last week when investors pulled out en masse from money market funds and the short-term debt markets that corporate America needs to fund its day-to-day operations, but he thinks the dangers of a depression are overstated. He wrote in his column that better regulation is part of the answer, but "today's financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future." In other words, they must reap what they have sown. No argument here.