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Confidence in US Banks Nosedives after Washington Mutual Collapse

JP Morgan's buyout of leading lender causes high street anxiety to reach panic levels

By Andrew Clark
Investors react to the Washington Mutual collapse

26/09/08 "The GuardianThe failure of the Seattle-based bank Washington Mutual undermined confidence in a fresh clutch of US household names today, as investors digested the implications of the biggest collapse of a high-street bank on record.

Washington Mutual, which was bought by JP Morgan after being seized by the US authorities late yesterday, had a stockpile of controversial "option ARM" mortgages which allow borrowers multiple options in setting the level of their own repayments.

These flexible loans, which were popular at the height of the housing boom, have proven to be huge liabilities for banks, and other firms known to hold them saw their stock prices plummet today.

Wachovia, a national chain with 3,000 branches and assets of $812bn (441bn), saw its shares dive by 21% during early trading in New York, while National City Corporation, a regional bank based in Ohio, suffered a sell-off which pushed its stock down by 27%.

Details emerged of the extent of a run on the assets of Washington Mutual, known as WaMu, in the days leading up to its demise. The Office of Thrift Supervision said customers withdrew $16.7bn of deposits in 10 days, beginning on September 15 - the day Lehman Brothers declared itself bankrupt, sparking a crisis of confidence in the broader banking system.

Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said the outflow alarmed WaMu's creditors, who became increasingly reluctant to extend funds. "Those who were willing to lend to them were no longer willing to do so," she said.

The FDIC reassured customers that all their money was safe. But it was clear that JP Morgan's offer to buy the Seattle bank's assets was a profound relief to regulators as America's insurance fund for banking deposits would have struggled to meet the bill - potentially requiring taxpayers to pick up any shortfall.

"We were fortunate - this is huge," said Bair. "We've protected taxpayers, we've protected depositors and we've protected the deposit insurance fund."

Last month, the FDIC said it had a "watch list" of 117 potentially troubled banks, holding a total of $78bn in assets. Bair said the list, which is updated quarterly, was growing as the financial crisis deepened.

WaMu's senior executives were caught on the hop when their firm was seized by the Office of Thrift Supervision. At the moment of the seizure, much of WaMu's leadership team was on a plane from New York to Seattle.

The bank's failure could generate a fresh outbreak of fury over executive compensation. WaMu's chief executive, Alan Fishman, joined the bank only three weeks ago from a rival, Sovereign Bank. He received a $7.5m signing-on bonus and could be eligible for $11.6m in severance pay.

WaMu has its roots in a savings association created to help Seattle residents rebuild after the city suffered a catastrophic fire in 1889. The bank has 2,239 branches across the US and employs 43,000 people. It is widely known for its television jingles which celebrate the bank's nickname, WaMu, with chants of "woo-hoo". In Seattle, there was gloom about the firm's demise.

"It's devastating" Steve Leahy, chairman of the city's chamber of commerce, told the Seattle Post-Intelligencer newspaper. "They've been here since the Seattle fire. The suddenness of all this, it's just taking our breath away."

JP Morgan's decision to ride to WaMu's rescue was the second time this year that it has snapped up the assets of a troubled rival. Aided by a Federal Reserve guarantee, JP Morgan bought Bear Stearns when it was on the brink of bankruptcy in March.

Financial historians pointed to a proud history at JP Morgan of acting to avert crisis. The bank's founder, John Pierpont Morgan, was credited with bringing together Wall Street bankers to come up with a rescue package to prop up failing finance houses at the height of a stockmarket panic in 1907. The bill was substantially lower in those days - federal authorities contributed $35m, compared to the $700bn industry-wide bail-out package under negotiation this week.

As the banking crisis continues to develop, recriminations are underway at regulatory authorities. The Securities and Exchange Commission was accused of performing only "sporadic and random" oversight of Wall Street broker-dealers in a report sent to Congress by its own inspector general today.

The report, which focuses on the demise of Bear Stearns, said the SEC's oversight arm was "not fulfilling its obligations" in reviewing the accounts of Wall Street's top financial institutions, hindering the ability to foresee weaknesses in the markets.

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