Direct answer: Washington Mutual failed because it built a mortgage portfolio concentrated in the highest-risk loan types, particularly option adjustable-rate mortgages where borrowers could choose to pay less than the interest due, allowing the unpaid interest to be added to the principal. When housing prices fell, borrowers who owed more than their homes were worth defaulted in large numbers. The bank's $307 billion in assets were seized by the FDIC in September 2008 and sold to JPMorgan Chase for $1.9 billion. WaMu had knowingly originated mortgages it called 'liar loans' as an internal term for no-documentation products.
Washington Mutual Investment Autopsy: What Actually Went Wrong?
The investment
Category: Financial Crisis Failure
Era: 2003-2008
Primary failure mechanism: credit risk / mortgage concentration / bank run
Ticker (at time): WM
What investors believed
WaMu was positioned as a high-growth retail bank aggressively capturing mortgage market share. Option ARM mortgages appeared highly profitable: initial payments were low (keeping borrowers current) while principal balances grew, and the bank earned fees from origination and securitization.
What broke
Option ARMs required eventual recasting at full amortization, dramatically increasing required payments. Borrowers had been qualifying based on minimum payments, not fully amortizing payments. When recasts arrived and housing prices had fallen, borrowers could not refinance and could not make full payments. Delinquency cascaded. Concurrent with credit losses, institutional depositors withdrew funds in September 2008 following Lehman's collapse.
Warning signals that were visible
- Rapid share gain in non-traditional mortgage products (option ARMs, no-doc loans) from 2003-2006
- Internal documents later revealed management awareness of loan quality problems
- Option ARM negative amortization creating rising loan-to-value ratios on the bank's books
- OTS regulator issued multiple cease-and-desist orders and capital warnings
Transferable lessons
- Rapid market share gain in financial products almost always involves moving down the credit quality spectrum
- Option features in mortgage products that allow principal to grow create a hidden credit time bomb
- A bank that internally describes its products as 'liar loans' has management making a deliberate choice about credit standards
- Bank equity is subordinate to deposits; in a credit-loss scenario, equity holders face full loss before depositors are impaired
Frequently Asked Questions
What is an option ARM mortgage?
An option adjustable-rate mortgage is a loan that gives borrowers multiple payment choices each month: a minimum payment that may be less than the interest due, an interest-only payment, a 15-year fully amortizing payment, or a 30-year fully amortizing payment. When borrowers choose the minimum payment, the shortfall between what they pay and the interest accruing is added to the loan principal, a process called negative amortization. Loans recast to fully amortizing payments after reaching certain principal limits (typically 110-125% of original loan amount) or after a set period. WaMu was one of the largest originators of option ARM loans in the United States.
Why did WaMu originate loans it knew were risky?
The fee economics of mortgage origination in the 2000s rewarded volume. WaMu earned origination fees immediately upon closing a loan, then securitized and sold most loans to the secondary market, transferring credit risk to investors while retaining servicing income. This 'originate to distribute' model reduced management's direct incentive to ensure loan quality, since they received income at origination and could sell the credit risk. WaMu retained more loans on its own balance sheet than many peers, which ultimately made the failure worse. The Senate Permanent Subcommittee on Investigations later documented that WaMu executives were aware of systemic loan quality problems and continued originating the products for fee income.
What did JPMorgan pay for WaMu and what did it get?
JPMorgan Chase paid $1.9 billion to the FDIC for WaMu's banking operations. This was a remarkably low price for a $307 billion bank, but JPMorgan specifically acquired only the deposits and some assets while the FDIC absorbed losses above a negotiated threshold. JPMorgan got WaMu's branch network, retail deposit base, and servicing portfolio. It took significant write-downs on the acquired loan portfolio over subsequent years. The acquisition expanded JPMorgan's retail presence substantially, particularly in California and Washington state markets where WaMu had been dominant.