Unlucky Number 13: Washington Mutual Fails

This post first appeared on Minyanville.

It’s official: The biggest bank failure in US history is now, well, history.

Last night, troubled thrift Washington Mutual (WM) collapsed into the open arms of JPMorgan (JPM), who again picked up a former competitor courtesy of a government-orchestrated bailout. The failure marks the 13th bank failure this year.

In the past 10 days, since the financial crisis began to escalate after the failure of Lehman Brothers and the government’s seizure of AIG (AIG), WaMu lost almost $17 billion in deposits, according to the Wall Street Journal. This exodus of cash left it in a precarious position, one regulators felt was too weak to allow the bank to continue as an independent entity.

Details are hazy, but JPMorgan will acquire the Seattle-based bank’s deposits, retail branches and certain other operations. Initial reports indicate the FDIC’s war chest to protect against bank failures won’t need to be tapped (some feared WaMu’s collapse would cost more than $20 billion to clean up). It remains unclear what will happen to WaMu’s battered loan portfolio.

WaMu has been trying to sell itself for weeks, after its share price fell so low that raising capital through traditional means became all but impossible, but potential suitors like Wells Fargo (WFC) and Citibank (C) balked when they got a good look at the bank’s books. Saddled with future losses on its deteriorating mortgage portfolio, even WaMu’s alluring footprint on the West Coast couldn’t coax an offer out of its suitors.

JPMorgan CEO Jamie Dimon, however, seems to have a penchant for making deals endorsed by the federal government.

Shareholders, who have already undergone considerable pain, will likely get nothing as a result of the takeover, and the Journal reports senior debt holders could be wiped out as well. This could set off a chain reaction in the market for credit default swaps, or financial insurance policies that allow traders and investors to bet on the likelihood of defaults on various debt instruments.

If in fact WaMu defaults on its senior debt, financial institutions that sold these swap agreements could face liabilities that dwarf the nominal value of the debt itself. The credit default swap market is huge and unregulated, and obligations to pay out in the event of default typically exceed the outstanding amount of the underlying security by orders of magnitude. This market is already busily trying to deal with the fallout from Lehman Brothers’ bankruptcy: Another round of defaults won’t simplify matters.

Almost 10 months ago, WaMu announced plans to lay off workers, close branches and scale back its lending operations in an attempt to cut costs. We noted on the Buzz at the time that WaMu has been ahead of the curve in nearly every aspect of the credit crunch, dating back to a decision in 2006 to stop buying loans from some of the small mortgage banking institutions that originated the worst quality loans during the mortgage bubble.

Since that time, banks of all shapes and sizes have cut costs, laid off workers and scaled back lending. It should come as no surprise if WaMu’s collapse is the first of many bank failures that make the FDIC’s first 12 "problem children" seem like toddlers in comparison.