By Jia Lynn Yang
Washington Post Staff Writer
Wednesday, November 10, 2010; 9:06 PM
Federal regulators and J.P. Morgan Chase - which together managed the collapse of Washington Mutual during the frenzied days of the financial crisis - are embroiled in a fight over who should cover billions of dollars from a legal mess that the failed Seattle thrift left behind.
The 2008 implosion of WaMu, as it's commonly known, was the biggest banking failure in U.S. history, prompting the Federal Deposit Insurance Corp. to take over the firm and then orchestrate a shotgun deal for J.P. Morgan to buy the bank for a paltry $1.9 billion.
But the paperwork for the merger was written so hastily over a 48-hour period that it left ambiguous who should cover the cost of WaMu's liabilities.
J.P. Morgan points the finger at the FDIC, saying that it agreed only to take on bank liabilities that were spelled out on WaMu's books during the handoff. The lawsuits weren't, hence, J.P. Morgan has said it is off the hook, according to legal filings.
The FDIC has said J.P. Morgan agreed to buy the bank, both the good and the bad.
The dispute is another reminder of the continuing fallout from the extraordinary - and very rushed - steps taken by the federal government to shore up the financial system as it was teetering on collapse. Decisions were made quickly, and the paperwork sealing massive mergers was signed without spelling out every consequence.
Ultimately, taxpayers could bear the brunt of those hasty actions. Experts say the law may indeed favor J.P. Morgan.
"J.P. Morgan has a very good shot of taking back a substantial portion of the $1.9 billion it paid for WaMu, even after having reaped what I think is a windfall," said Kevin Starke, an analyst with CRT Capital Group.
WaMu is being sued by large investors who say the banking giant sold securities full of mortgages but misrepresented how risky they were.
The representative of these investors, Deutsche Bank National Trust, has not singled out which of WaMu's past owners should pay up. It instead filed suit against both the FDIC and J.P. Morgan claiming $6 billion to $10 billion in damages for violating contracts.
J.P. Morgan officials declined to comment on the matter. But in the bank's third-quarter financial filings this week, it said "such repurchase obligations remain with the FDIC receivership."
The FDIC has filed a motion for a judge to dismiss Deutsche Bank's suit, stating it was not liable to Deutsche Bank and that J.P. Morgan "expressly assumed" liabilities of the company. A spokesman for the FDIC declined to comment.
The dispute between the FDIC and J.P. Morgan hinges on the interpretation of one section in the WaMu sale agreement to J.P. Morgan on Sept. 25, 2008.
According to the document, J.P. Morgan agreed to "pay, perform, and discharge all of the liabilities of the Failed Bank which are reflected on the Books and Records of the Failed Bank as of Bank Closing."
The liabilities from mortgage security lawsuits weren't listed on those "Books and Records," according to J.P. Morgan. Eventually, a federal judge in the District will decide whether the bank's claim has merits.
In its filings, J.P. Morgan estimates that from 2005 to 2008 - roughly the peak of WaMu's subprime lending frenzy - WaMu sold $150 billion of loans to Fannie Mae and Freddie Mac. The bank added that the FDIC is responsible for covering the cost of any loans that Fannie and Freddie want to return, as well.
If the interpretation of the agreement is unclear, it's because the FDIC at the time was in such a hurry to make the sale. No other bidders had emerged for what was then the country's biggest savings and loan. J.P. Morgan, meanwhile, had ambitions of expanding into California and Florida, making WaMu's presence on the West Coast especially attractive. Plus, the $1.9 billion price tag was a bargain.
The deal allowed the FDIC to avoid losing any money from its handling of WaMu's failure. J.P. Morgan instead absorbed $31 billion in losses and inherited a portfolio laden with bad loans.
But J.P. Morgan has since benefited greatly from the deal. Starke estimates that the bank can claim about $2 billion in tax refunds from the WaMu acquisition. He added that the bank has also gotten a $5 billion windfall from inheriting WaMu's life insurance policies.
It's not a foregone conclusion that the investor lawsuits against J.P. Morgan and the FDIC will succeed. Investors have so far struggled to prove that banks had poor underwriting standards. In order to make their case, they need critical loan information that's being held - and not released - by the banks.