The Largest Bank Failure in US History - Research Paper Example

The Largest Bank Failure in US History Introduction Washington Mutual (Wa-Mu) was the biggest bank failure in the history of US, the sixth largest bank then in 2008. Regulator seized the Washington Mutual and then sold it to JP Morgan Chase for $1.09 billion. JP Morgan acquired only the assets and deposits of Wa-Mu and not the debts and equities. This amounted to wiping out of equity and non- deposit lenders. Was this an ethical move to wipe out equity holders and non deposit lenders? JP Morgan Chase paid 1.09 billion to the regulators who didn’t have any stake in the bank? Moreover, the regulators were never responsible even for the insurance cost of the deposits of the bank. Then why this acquisition ignoring the equity holders and non- deposit lenders was recommended by the regulators? The moral and ethical understanding of the decision of the regulator has been examined in this write up by evaluating the issue of bank failure and its takeover by J P Morgan Chase from the point of view of framework of ethical considerations incorporating the six pillars of the character, called trustworthiness, respect, responsibility, fairness, caring, and citizenship. Contents Introduction Ethical Framework and Takeover of WA-Mu Takeover viewed as per parameters of six pillars of character Conclusion Ethical framework and takeover of Wa-Mu Being ethical does not necessarily mean legally or religiously correct. Sometimes the subtleties of an issue are beyond understanding, and under such situations use of knowledge of other agencies can be helpful in taking an ethical decision. The seized assets of the Washington Mutual were worth $307 billion and placed under the receivership of FDIC (Federal Deposit Insurance Corporation). It is claimed that intervention of the FDIC was to rescue other financial institutions. Was it ethical to suggest takeover of Wa-Mu in order to help others to continue? It is stated in OECD (2008) surveys that FDIC had to intervene to rescue other small banks. Though small banks revived but impact of Wa- Mu failure on other stakeholders was severe. “Small banks started becoming solvents. Many had debt investments with Fannie Mae and Freddie Mac, and when they became insolvent, the effects were immediately felt by small banks. The failure of Washington Mutual caused equity and debt holders to lose their entire investments. Mutual Funds and insurance companies holding Washington Mutual bonds lost almost all of their investments. This would include many retirement people whose entire income, except for a small social security check, was then lost.” (Rodney Stich, 2008)i Ethical decision making is a process where least numbers of disputes arise. FDIC was fully aware that the debts that were not taken over included life time savings of retired persons as well. It was the duty of FDIC to take care of such issues and take- over a judicious view point. “The process of ethical reasoning must avail the decision maker with a safe or valid alternative from a multitude of alternatives presented by ethical problems. The safe alternative is the way out of ethical muddles presented by ethical problems.”(Joseph Migga Kizza, 2010)ii It appears that the stakes of non deposit debtors and equity holders were considered less important than others in ethical reasoning process of FDIC. Otherwise, there is no point of non- consideration of the stakes of equity holders. A logical reasoning to this conclusion of FDIC is that FDIC might have found negative net worth of Wa Mu and that is why the fully paid equity holders were ignored. Washington Mutual specialized in home mortgages, credit cards, and other retail lending. These areas of lending had become a playground for unscrupulous loan brokers, lenders, appraisers, undertakers, and bank executives. Bribery in exchange of approving loan applications was doctored by or for the borrowers who had no repayment capacities. Where were ethics at this stage when peoples’ savings were being risked by putting them as loans to borrowers with no capacity to make repayments? The intermediaries became lusty, and “this lust for money became the root cause of debacle. The cycle fueled by Wall Street securitization of billions of dollars of fraudulently processed and default- prone loans that generated outlandish paydays for everyone from top Wall Street executives to Main Street sub-prime mortgage broker brought a fog of avarice over the entire financial system, ultimately dooming it to its inevitable crash and burn” (Peter Goldmann, 2010)iii. Ethical banking was thrown out of the window. There was no truthfulness. The highest risk area for a bank is the fraud in distribution of loans. With virtually no internal controls to prevent distribution of fraudulent loans, any trickster could submit loan application using all factious information. The dishonest employees who were associated with such loan would take care of all the weak points of borrower. Once such fraudulently sanctioned loan gets disbursed, there are always dim chances of any recovery from the borrower of such loan. Bank will always deal with such loans as per established policies, and that means enough time for the borrower to manipulate many things in his favor causing heavy financial losses to the bank. All these things happened unchecked for years. Morality or ethical attitude was a matter that never bothered those involved with perpetrators of such frauds. Naturally these activities were not only financial dangerous to the institution but also to the public at large. It appeared from above that the functioning of the bank in respect of grant of home mortgages, credit cards, and other retail lending was not only unprofessional but also unethical. Public funds were unscrupulously distributed for illegal loans with bleak chances of recovery; and this is one of the basic reasons for the failure of Washington Mutual. The bank failed in September 2008 and was taken over by J P Morgan under a reorganization scheme, where under equity holders and non- deposit lenders were deprived of their stakes. If illegal distribution of funds as loan was unethical, then the proposal to ignore the real stakeholders is also uncalled far. If such denial is due to the fact that the entire capital of Washington Mutual was wiped out because of illegal distribution of fund, then technically the stakeholders do not have any claim provided all other available alternatives have been explored. For this the entire scheme of reorganization as presented to court is required to be examined to verify whether all alternatives were explored. However, as per the latest information from the FDIC’s board has approved global settlement. This agreement settles all the claim issues between Washington Mutual and JPMorgan Chase & Co. However, this settlement still requires court approval. Though the news from Bloomberg indicates that the reorganization scheme was clearly drawn as per the available information about finances of the company, yet the reorganization scheme will attain the status of ethical solution only upon legal nod of approval by the court. Takeover assessed as per parameters of Six Pillars of Character Trustworthiness promotes candidness and this virtue is the basis of all relations, whether commercial or otherwise. Wa- Mu agreed to be truthful to the shareholders when they invested their savings into enterprises. But Washington Mutual could not keep this shade of the character as promised to its investors. The company had to file bankruptcy as it could not be truthful to its stakeholders. “In June 2008 Washington Mutual Bank had assets in excess of $300 billion with over 2200 branch offices in 15 states. On September 15, 2008 the holding company received a credit agency rating downgrade creating a run on deposits of its bank, resulting in withdrawal over $16 billion in 10days period. On September 25, 2008 Washington Mutual bank was seized by office of Thrift Supervision and placed in receivership with FDIC, representing the largest bank failure in American history.”(Jerry Evans, 2009)iv This sequence of events is enough display of distrustfulness of Washington Mutual with its investors and other stakeholders. Respect is next pillar of character that has not been incorporated while framing the reorganization scheme of takeover of Washington Mutual by J P Morgan Chase & Co. It has been reported by Robert Sorbo (2010, May 24)v that a group of senior bondholders of Washington Mutual Inc opposed the group settlement reached with Federal Deposit Insurance Corporation over the thrift’s September 2008 failure. There appears to be partiality in repayment to bond holders. As per the representative of senior bondholders “it was unfair that note holders of holding company would be paid in full, while senior note holders at the bank unit level would not receive anything close to full payment.” This reflects that note holders of different categories were never dealt with respect in the proposed settlement offered in the scheme. But the ills of partiality and favoritism are being reflected in the schemes of settlement. Thus takeover schemes have completely ignored the respect pillar of the character. Responsibility is that virtue of a character that promotes accountability, self restraint and tolerance. “Responsibility is described as being honorable as a person, doing one’s duty, being accountable, doing one’s best by pursuing excellence, and exercising self control.” (F.Clark Power, viewed on 21.07.10)vi The big inquest for exploring the responsibility virtue in case of Wa-Mu failure is whether the bank was playing with people’s fund with a sense of responsibility. Bank was taking unconscionable risks with other people’s money, and at the same time providing huge remunerations to staff. “Wa Mu CEO Kerry Killinger wasn’t the part of Wall Street club. He collected a $25 million severance when he left and was paid $103 million from 2003 to 2008.” (Nick Malden, 20 April, 2010)vii. Huge salary and irresponsible executions of duties appears to be the feature of character of erstwhile CEO Kerry Killinger. That is the reason bank funds were employed to activities that did not deserve such employment of fund. A sense of accountability was completely missing. The aim was to enhance the business without its bothering about recoveries. With the result bank suffered hugely and failed beyond repairs. This explains that whenever an institution becomes irresponsible and cannot even account for its actions, the inevitable is bound to happen. You may call it the result of credit crunch; but the fact the bank’s failure was the result of irresponsible and unaccountable behavior of those at the helm delay of affairs. Fairness of the character demonstrates impartial approach and equitable execution of duties. Washington Mutual was exposed to the problems of sub- prime mortgages. Its recoveries were at lowest ebb. This was the result of complete impartial business approach on part of the bank. It is always a struggle to keep up the mortgage payments. But when there is no equitable execution of duties, the character of the entity is bound to reflect in the response from its customers. In a compliant one customer, an army man fighting in Iraq complained that his timely payments from abroad were not being posted in time, and in turn he was levied penalties. Despite his pleadings, that delay was caused in records of Wa Mu because of time difference in place of remittances and the US was not heard at all. That duties performed by Wa-Mu staff were not fair for all. Accordingly its effect on the financial results would have been worst if customers like this army man choose, in return, not to pay timely payments when he had to pay charges for all types of payments. The result for not dealing fairly with its customers is there as the bank had to close down due bad financial health. Caring is a compassionate feeling for interaction with others. Under this quality of the character one has to be very clear about terms of the business schemes that are being offered to clients. Caring attitude of Washington Mutual towards its business was at lowest ebb, as is clear from the report of Sara Hanshard (13 April 2010)viii. As per report one James Vanasek, Chief credit officer of Wa Mu testified to a senate subcommittee that “Washington Mutual was a reflection of the mortgage industry, characterized by very fast growth, rapidly expanding product lines, and deteriorating credit underwriting. This was a hyper competitive environment in which mistakes were made by loan originators, lending institutions, regulatory agencies, rating agencies, investment banks that packaged and sold mortgage- backed securities, and the institutions that purchased these excessively- complex instruments.” Simply there was no caring attitude from any of those agencies that were connected with enhancing the mortgage loan business. Naturally there would be disastrous results when caring aspect of the business character was completely missing. Citizenship reflects the law abiding character of a personality or of an entity while executing duties and responsibilities. This aspect of the business character was not there at all when different financial products were being sold by Wa Mu. Nobody cared for rules and regulations right from loan originators to regulatory agencies. A business mess was created with no alternative to clear this mess. The result was inevitable, and the bank failed because of individual failure and system failure of not abiding the laid down rules and regulations of the business. Conclusion The failure of Washington Mutual bank in September 2008 was the result of unethical banking by unscrupulous loan brokers, lenders, appraisers, undertakers, and bank executives. The inevitable was bound to happen; but during the course the equity capital and non deposit loan funds vanished from the kitty of the bank. Ethical evaluation of the takeover has revealed that there were no other alternative before FDIC except to recommend takeover of the bank. The decision, judged from the point of view of framework of ethical decision making, was the right course of action as the responsibilities of bank failure lie with unscrupulous and unethical business practices that remained unchecked for a long time. The bank should have acted professionally and checked unscrupulous and fraudulent banking activities; but that never happened. These findings are the results of critical assessment of the takeover decision in the light of basic principles called six pillars of a character. The takeover decision was the only way out even though it harmed many stakeholders. Word Count: 2474 References Read More