Auctioning Off WaMu (WM)

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No one in his right mind wants to buy Washington Mutual (WM), but it does have some juicy pieces which would make nice additions at several other large financial firms. That leaves open the question of what happens to the bank’s mortgage business, but why confuse the situation with minor details.

Moody’s cut WaMu to "junk". According to Reuters, the ratings agency cut the Seattle-based thrift’s senior unsecured debt rating two notches to "Ba2." That will make all the capital the bank needs to raise much harder to come by. Washington Mutual has already forecast a projected a $4.5 billion third-quarter increase in reserves for bad loans.

The mortgage bank has good consumer investment and banking businesses. It also has a business banking operation which is likely to be worth a substantial amount. But, those strong businesses do not seem to matter. Washington Mutual’s market cap has dropped from $55 billion to $5 billion in less than a year. If Wall Street is right about the value of the company, and its better business units have kept most of their worth, the mortgage assets and derivatives held by the bank have a negative value of $30 billion or $40 billion, on a good day.

The government is not going to let WaMu fail, at least in the classic sense. If the nominal value of the company’s mortgage paper is so terribly and deeply compromised, a bankruptcy of the firm would undermine the market’s valuation of similar assets held by several other banks and brokerage firms.

The Fed and Treasury are going to have to take a hard look at what amount of money they will need to put a floor on the value of WaMu’s troubled assets. At that point they can be auctioned off to another financial institution or private equity firm based on the assumption that the loans and related investments will regain some of their worth once the housing market begins to recover. A buyer who is willing to wait two or three years might get an outsized return.

No one is going to undertake the risk of holding WaMu’s bad paper and riding out the storm unless Treasury Secretary Henry Paulson and his friends offer a guaranteed foundation which creates a basic value for the portfolio.

It is the only way out for WaMu and for a government trying to salvage the nation’s banking system.

Douglas A. McIntyre