Understanding Business Failure of Washington Mutual Bank - Case Study Example

Understanding Business Failure

Introduction

Washington Mutual Bank was one of the six largest banks in U.S.A. It was part of the largest Savings and loans association in America. The Bank was a finance and insurance company, which was part of the Washington Mutual Inc., founded in 1989 with its headquarters in Seattle, Washington. Some of its subsidiaries included the bank’s investments, insurance services, and service Cards. The bank collapsed in 2008 after the U.S. Office of Thrift Supervision held the bank from its parent incorporation. The Federal Deposit Insurance Cooperation placed the bank under bankruptcy. The organization took the action after thy suspected withdrawals amounting to 16 billion U.S. dollars in a 9-day bank run, which was approximately 10 percent of the total deposits. The Federal Deposit Insurance Cooperation seized all Washington Mutual Bank’s assets (Ryssdal 2013, pp. 1).

The following day after the seizure, JPMorgan Chase bought Washington Mutual subsidiaries from the Federal Deposit Insurance Corporation for approximately 2 billion dollars. The deal did not include unsecured debts and equality claims. JPMorgan Chase rebranded all Washington Mutual Bank branches as Chase the following year. There, Washington Mutual Inc., which was the holding company, remained with assets totalling to 33 billion dollars. When the Federal Deposit Insurance Corporation stripped off the Subsidiaries from the Washington Mutual Inc., the company incurred debts amounting to 8 billion dollars. The Washington Mutual Inc. filed a case for voluntary liquidation in 2008 (Dunbar & Donald 2009, pp.1).

According to the American financial history, Washington Mutual Bank collapse, with all the assets under its management. The collapse remains the largest bank failure in history. Before the collapse of the Bank, filings from the Washington Mutual Inc. revealed that the company had holding assets estimated at 328 billion USD.

The Washington Mutual Inc. sued the Federal Deposit Insurance Corporation at the District Court of Columbia in 2009 seeking damages amounting to 13 million dollars. The incorporation claimed that the Washington Mutual Bank seizure was unjustified and that they sold if to chase at a low price. However, Chase also filed a petition in a Court in Delaware where the liquidation case was being held since the seizure of the Washington Mutual Bank.

Systematic Multi-level Cause Analysis

Macro- Economic Causes of the Bank’s collapse

The major root-cause of Washington Mutual Bank was bankruptcy. The bank was exploring profit and growth, which led to origination and securitization of funds into high danger, low quality bank loans that finally dropped in price. It affected the stakeholders, the bank, and the financial structure of the U.S. The bank’s high risks loans increased from 19 to 55 percent in in a four-year period. On the contrary, the bank’s fixed loan rates decreased from 60 to 25 percent within that time limit (Subcommittee 2011, pp.2).

Furthermore, Washington Mutual also instigated a collective amount of Option Adjustable Rate Mortgage that increased the risk, which negatively remunerated mortgages. The product represented approximately half of the bank’s loan origination for a period of 5 years from 2003. The bank originated about 40 billion dollars in Option ARM loans and sold approximately 115 billion dollars to investors. Beside, Washington Mutual Bank amplified its instigation and securitization of high threat home parity loans. The home equity loans was 63 billion dollars by 2007. It recorded a 130 percent increase from 2003.

Meso-Economic Causes of the Failure

High Lending Strategies

One of the root causes of Washington Mutual Bank failure was the adoption of the lending strategy that aimed at pursuing higher profits. The bank emphasized on high-risk loans in 2004, 4 years prior to its collapse. The high-risk credits began experiencing high amounts of delinquency and evasions two years later. In 2007, the bank’s mortgage backed securities started experiencing losses and its ratings dropped (Ivashina & Scharfstein, 2010, pp.319). Besides, Washington Mutual Bank began experiencing losses because of an assortment that included reduced quality, deceitful loans, and sales. The standard price of the company fell and the stakeholders lost trust in the bank. Additionally, depositors started withdrawing their assets resulting to a liquidity crisis in the bank (Subcommittee 2011, pp.2).

As the Washington Mutual Bank and the Long Beach took part in sub-standard lending practices while effecting its high-risk borrowing approach, they were approving high-risk clients for enormous loans than what they could manage to pay. Besides, they were directing loan borrowers from predictable mortgages to high-risk loans. Furthermore, the bank was accepting large loan borrowers without assessing their financial income. Loans with multiple layers of risks were being issues besides promoting negatively amortizing loans where the number of borrowers increased instead of repayments. Furthermore, the bank did not implement any enforcements for their compliance on their loans resulting in multiple credit errors. Furthermore, the bank and the Long Beach designed compensation enticements to borrowers for issuance of large volumes of higher-risk loans that valued the speed and quantity rather than credit quality (Subcommittee 2011, pp.2).

Finally, Washington Mutual Bank and its subsidiary, Long Beach was widely known for the unsuccessful loans and the worse performing housing mortgages supported securities. The bank’s management was handed the compelling evidence of its deficient lending practices. The bank’s internal reviewers described how employees willingly extended fraud and knowingly by-passed bank policies. Comparatively, investors deemed the internal controls to stop fraud within the bank ineffective. On one occasion, a senior manager in the bank knowingly sold law-breaking loans to borrowers. In detail, the following are the main root causes of Washington Mutual Bank’s collapse.

The strategies were the main reason for the failure of Washington Mutual Bank. The bank’s executives focused on implementation of a High Risk Lending Strategy. Besides, the company improved the sale of high-risk loans. The management hoped that increased high-risk loans would increase profits than the low-risk loans because of the highly charged interest rates. However, it incurred many loan errors in the process, coupled with fraudulent tendencies, which caused significant losses to the company by 2008 (Subcommittee 2011, pp.2).

Sub-standard Lending Practices

Washington Mutual Bank and its subsidiary, the Long Beach, applied sub-standard lending practices damaged with credits, compliance, functional deficiencies to delivery, and multiple high-risk home loans. The practices were highly risky, with numerous errors and fraudulent activities taking place that widely contributed to the collapse of the company.

Micro Economic Causes of Failure

Directing Borrowers to Highly Risky Loans

The Bank alongside the Long Beach frequently directed clients into loans, which they could barely manage to repay. The practice encouraged borrowers by giving them an offer to make small initial payments before the higher payments. They assumed that the hiking home prices could push the clients to refinance their mortgages or sell their houses prior to payments increase (Subcommittee 2011, pp.50).

Pollution of the Financial Structure

Washington Mutual Bank and its subsidiary securitized approximately 80 billion dollars in subprime mortgages as well as high-risk home loans. Besides, they utilized the Wall Street organisations to market their securities to stakeholders globally. Therefore, they adulterated the financial structure with loan-backed securities that eventually experienced higher losses and lawbreaking tariffs (Subcommittee 2011, pp.50).

Securitizing Lawbreaking and Fraudulent Loans

The bank sometimes highlighted and securitized credits that it identified and deemed as law breaking and devoid of informing the investigation to investors. Moreover, Washington Mutual Bank securitized loans, which were polluted by frauds, without informing the clients about the malpractices revealed (MacCoy 2009, pp.493).

Negative Compensation

Washington Mutual Bank compensation system remunerated loan-processing officers for originating great amounts of risk credits. Additionally, the bank rewarded those officers that overpriced clients and supplemented firm payment consequences. The bank also awarded its executives with millions despite the bank being profoundly jeopardized.

Deficiencies

Apart from the discussed root causes, the Office of the Thrift Supervision also identified deficiencies, which backed the failure of the bank. Foremost, the Washington Mutual Bank experienced weaknesses in lending standards. Lending standards determine the types of loans that it offered by the loan officer or acquired from a third party. The bank’s lending standards were unsatisfactory because the standards set were very low. Besides, the loans issued were risky, and there were high chances of no repayment. Therefore, the standards were exposing the Washington Mutual to later losses, which contributed to its failures (Subcommittee 2011, pp.177).

Secondly, the Washington Mutual Bank experienced risk management deficiencies. The risk management practices of the bank were deficient. The risks experienced included lending standards that produce profitable loans, standard enforcement, and loan assortment evaluation. Furthermore, it included identifying of loans that may default and devising measure to manage the identified risks. Washington Mutual Bank failed to determine the potential risks at earlier stages. Besides, the management did not take proper action to manage these risks, which collapsed the bank.

Thirdly, the bank had deficiencies relating to Long Beach. Washington Mutual Inc. purchased Long Beach Company. The Washington Mutual Bank and its subsidiary collaboratively sold subprime loans. The Long Beach Company was associated with loaning and risk standards, issue of low-value loans, and loan financed sales. The deficiencies identified included weaknesses in loan servicing, documentation, and exceptions. There were also weak compliance strategies and high delinquencies (Subcommittee 2011, pp.191).

Regulatory Failures

Lastly, failed regulation also caused the collapse of Washington Mutual Bank. The Office of the Thrift Supervision identified most of the bank’s deficiencies, which were handed to the management to take prompt action for five years no matter the lack of enforcement from the management. The examiners were, therefore, demoralized because from 2003 until the bank collapsed, they could identify serious problems in the bank, but no measures were taken. Besides, the bank’s short-term profits were used as an excuse for the venture into high-risk loan practices and ignored risks (Subcommittee 2011, pp.209).

Exit Strategy for Washington Mutual Bank

Turnaround is the process of corporate renewal. It considers the analysis and strategies that a company should take to bring it back to solvency. Turnaround identifies the reasons for market failure and corrects them. The turnaround management involves management review, analysis of root failure cause, and ‘’ SWOT analysis’’ to ascertain the primary drive to failure. It creates a long strategic and restructuring plan. On approval, turnaround professionals implement the plan and continuously review its progress, and take the corrective action required to ensure that the company returns to solvency.

Exit strategy is a means of leaving current situation after achieving predetermined goal or as a strategy to mitigate failure. The strategy is a way of ‘’cashing out’’ an investment. The selling of the investment may be through initial public offering, or bought by a larger company within the industry. JPMorgan Chase acquired Washington Mutual Bank, which was a subsidiary of Washington Mutual Inc. fully. The Thrift Supervision and Federal Deposit Insurance Corporation offices facilitated this transaction (Fürth & Rauch 2015 pp.19). This acquisition is an exit strategy to Washington Mutual Bank since it is a sale of an investment.

Some exit strategies are applied in the case of Washington Mutual Bank. Foremost, liquidation is most applicable. In liquidation, the remnants from the assets must be repaid to the creditors. The shareholders then share then remaining assets. The strategy has an advantage of no transfer control incurred. Secondly, merger and acquisition is also an important strategy. The Bank could merge back to its parent incorporation. Thereby combining both of their resources, which would be efficient revenue generation. Trade sell is another option where the bank was sold to Chase, and the assets were used to repay its debts. Besides getting the best price for the businesses, profits can also be realized to remunerate the shareholders. Lastly, initial public offering is a strategy that would ensure the security of the stock.

An organization may sell its investments for various reasons. If the investment no longer fits the goals set then it can be a good time to make sales. Every organization has an objective to achieve. Ones this cannot be fulfilled then selling it and finding another one is the best option. It is good to sell an investment that does not maintain its previous impression. If an investment outperforms other similar investments, then it is a good sale. The reasons for sale should be determined before making the decision of selling an investment. The value of the investment should be determined by a qualified person to avoid underprizing the business being sold. Public bidding is crucial as it narrows the chances for corruption.

The collapse of Washington Mutual Bank took place after worried depositors withdrew $16.7 billion within ten days of operation before its collapse. This created nationwide financial panic and (FDIC) quickly placed it under receivership. The (OTS) seized the bank because of the 16.7 billion withdrawals by customers within nine-days of bank operation. JPMorgan Chase bought the banking branches from (FDIC) for $1.9 billion. JPMorgan Chase had an internal confidential plan nicknamed Project West. The plan was to take-over Washington Mutual Bank that was a subsidiary of Washington Mutual Insurance. There had been many attempts by JPMorgan to acquire Washington Mutual Bank but its shareholders declined. By the end of 2009, all the subsidiaries of Washington Mutual Inc. (WaMu) became subsidiaries of JPMorgan Chase. WaMu remained with assets worth $33 billion and debt of $8 billion. The following day WaMu applied for chapter 11 of bankruptcy Act at its headquarters located in Delaware. This became the largest bank failure in American history given its large total asset management.

The closure and acquisition of Washington Mutual Bank was not the right decision since its asset base of $307 billion and $188 billion of deposits was enough to compensate its customers. The political process facilitated the collapse of WaMu. Considering its size and big loss indicated on its loan portfolio, people might have expected its financial pain and collapse to spread widely and over a long period. However, this was not the case. After two years, it became apparent that there were many winners and few losers in the banking failure history. The bank’s top executive officials received no punishment for their actions. JPMorgan assumed all loans, leaving unsecured creditors and shareholders with large losses. This proved the collaboration between different officials in closing the bank.

The bank had a larger market share at the time of acquisition. It was the sixth largest bank in the United States at the time of its closure. The policy makers, top executives of the bank and JPMorgan Chase jointly contributed to its collapse. Washington Mutual Inc. has a plan of establishing liquidating trust to make distribution to the parties in an account of their allowed claims. The approval of this plan by the Bankruptcy Courts will ensure that the company’s shareholders and unsecured debtors recover their losses.

Conclusion

The company failed because of incompetent, corrupt and self-interested managers. The top-level managers lend high-risk loans to customers leading to default in payment (Cole & White 2012, p 7). They corrupted the financial system and gave fraudulent loans making the bank to lose money. The internal control system also failed since nobody considered the evidence given by staffs in emails, audit reviews, and report. Long Beach Mortgage Company informed the president and the CEO of the bank of serious fraud. However, the bank tried to stop it but failed. The senior management sold delinquency loans to investors.

The regulatory office (OTS) did not try stopping the unsafe and unsound practices at WaMu. This contributed to the downfall of WaMu. Over the past years, the bank experienced many problems, which include managing lending, asset quality, controlling risk and appraisal techniques. The bank promised regulatory office that they were going to fix the problems, but this never happened. OTS did not mind following up the enforcement Act and in 1992, WaMu completed the deal of buying Long Beach Mortgage Company. It then began bad lending practices. WaMu realized that the issuing of loans were illegal since most applications contained signatures that were different. However, bank did not take caution even after the warning.

The incompetent nature of a company’s management can cause its failure. WaMu had strong market share but failed because its senior managers were corrupt and dishonest in their dealings. The managers participated indirectly in the collapse of the company by refusing to take necessary actions against violators. They were also involved in illegal transactions to fulfil their self-interest. These led to the collapse of Washington Mutual Bank.

In summary, businesses and investors should remember the Washington Mutual Bank case to prevent the recurrence of future failures. This will act as an example to future shareholders and the policy makers in selecting corporations’ executive managers. They should ensure that the managers are competent by checking their past records before allowing them in office.