What Have You Done, Jamie Dimon?

Should the economy worsen dramatically over the next several years, the rescue of Washington Mutual (WM) by JPMorgan Chase (JPM) will be remembered as the event that brought the American financial system to its knees. 

While the terms garnered by JPMorgan may appear favorable on first review, the deal raises far more questions than it answers in regards to the health of the financial system of the United States.  There is a significant possibility that this rescue may have begun the process by which the financial risk of lesser banks is thrown upon the three majors in an attempt to save the entire financial system.

In concentrating the financial risk of our system in JPMorgan, Citigroup (C) & Bank of America (BAC) there is the acute chance that we will inadvertently kill our rescuers, leaving us no choice but to rely on a federal assumption of banks that are truly too big to fail.  Should the economy take a dramatic turn for the worse and unemployment rise dramatically, JPMorgan’s current loss assumptions will prove shortsighted. 

As we have seen over the last several months, when such assumptions are realized by the investment community to be inadequate, terrible things happen.  JPMorgan, with its massive derivative exposure, can ill afford the unfortunate series of events that will undoubtedly come about should the losses associated with the Washington Mutual acquisition prove considerably larger than currently expected.  

Based on JPMorgan’s current estimates the purchase of Washington Mutual will cost the venerable bank very little, namely a $1.8B dollar payment to the FDIC, an $8B dollar capital raise and a $31B dollar write down of the firm’s newly acquired loan portfolio.  While I certainly have no qualms with the first two items, the third appears to be questionable.  Below is a table of JPMorgan’s assumed losses on Washington Mutual’s loan portfolio:

	Projected Remaining Losses as of 9/30/08 ($B)	Estimated Balance as of 9/30/08
Option ARMs	$10.346	$50.300
Mortgage	2.183	51.100
HE Loans & Lines	11.739	59.500
Subprime	6.438	15.100

The home equity [HE] and mortgage loss assumptions are almost laughable in my opinion as they place far too much faith in Washington Mutual’s underwriting capabilities.  Unless there is a profound turnaround in the real estate markets out West, I simply do not see how losses on the home equity loans will not be much higher then currently expected.  It seems reasonable to me that JPMorgan should have marked the loss assumptions for home equity loans up to such a level so that they match the percentage decline of home prices in the most depressed housing markets. 

According to JPMorgan’s own assumptions the company expects losses to expand to $42B should the recession deepen and $54B should the recession become “severe”.  These figures would represent an $11B and $23B dollar reduction of capital at the bank on top of the $31B dollar write down that JPMorgan has agreed to take initially.  It is important to note that these figures take into account 7.5% and 8.0% unemployment respectively.

Throughout the credit crisis and for that matter throughout its history, JPMorgan has been viewed as having a fortress-like balance sheet.  The Washington Mutual acquisition should put to an end this belief in the impenetrability of JPMorgan’s balance sheet, especially if the economy were to worsen. 

At the end of September, JPMorgan will have a capital base of $107B and a Tier 1 Capital Ratio of 8.3%.  While the company’s capital base will have increased from $99B at the end of June, the Tier 1 Capital Ratio will have fallen dramatically as it stood at 9.2% in June.  Such a rapid decline in this key metric is appalling, as it would suggest that JPMorgan is now nothing but a mere mortal.  

Should the country enter a “severe” recession, as defined by JPMorgan, the company would find itself with a Tier 1 Capital Ratio that would be quickly approaching 7% (barring additional capital raises).  When compared to its peers' capital ratios, which can be found here, we would see that JPMorgan would have the lowest capital ratio of them all should events unfold in such a manner. 

The loss of its fortress-like balance sheet will likely place the company under considerable strain as it will force it to restrain its derivative and investment bank operations.  The future, while still existing for JPMorgan, has gotten bleaker with the acquisition of Washington Mutual.  If we were to continue with the “fortress” metaphor, it is as if Jamie Dimon has lowered the drawbridge, raised the gates and proceeded to welcome the Barbarians into Camelot. 

For Further Review:

NY Times Article on the Deal

JPMorgan Presentation 

Disclosure: None

Comments

[lucky lenny:]

I still don't understand why Wamu was seized by the FDIC. Wamu had tons of equity; was meeting customer withdrawals; & just rec'd a $7 bill cash infusion. Thanks.

2008 Sep 28 05:47 AM

[Vobogeck:]

Because depositors withdrew $16 billion from their accounts in less than a week. WM had no liquid assets left. A classic run on the bank. The biggest mystery is why the Feds have not increased deposit insurance to $250k and then extensively communicated through TV ads, etc that this insurance is available to depositors in ALL financial institutions.

2008 Sep 28 10:02 AM

[corellian98:]

The only thing I know....is that it didn't have to end this way. Think about the wealth that was lost by a single stroke of the pen....shareholders AND debt holders alike. What were they thinking? This can only cause more problems and in the days ahead...everybody will see, but by then it will be too late.

2008 Sep 28 10:59 AM

[whidbey:]

Jamie was always a high wire act, and he still is. He feels he is building a monument to his financial genius, but he also feels lucky in that he is now too big to fail: he can not lose and he is home free. But, we all know that the comment above is correct, If JPM goes so goes the US financial system. Its credibility is already shot, and this does not help. Just keep piling the crap deeper hoping to reach the top of the hole. Won't work, even with Jamie.

2008 Sep 28 12:48 PM

[Bugs:]

J.P. Morgan (JPM) used to be the bank with the AAA rating who served corporate America's banking needs. Chase Manhatten (CMB) was the older, commercial bank. The merger created a world class bank. J.P Morgan Chase is now a world wide bank. Stronger by its roots than it's only rival, Citigroup. Second guesing them is useless, they are the pinnacle.

2008 Sep 28 02:03 PM

[nyka:]

Bugs-- befoere commenting, learn that IT'S means IT IS. Did you really mean to write... than IT IS only rival? We hope not. Try...than ITS only rival...

2008 Sep 28 06:01 PM

[Kinabalu:]

I don't agree with this at all. The fact is that the FDIC has been promoting bank consolidations for twenty years. Maybe the FDIC is consolidating bank risk. But to conclude that therefore, this is a bad deal for JPM, is stupid. I am absolutely amazed that they were able to acquire these deposits and branches for the price they got. The FDIC should be ashamed. This is a GREAT deal for JPM. They will be benefitting from this for years.

2008 Sep 28 07:53 PM

[User 272175:]

This is a sad day for all of us shareholders and employees of WaMu... we were robbed blind by the feds and no one said or did anything. Chase, like other firms were circling like vultures, waiting for the feds to move in. They all knew what was going on... this was the plan from beginning on the week of the take over...

The run on the bank was caused by the media and not one agency thought of regulating them or to set the record straight... they let the run on the bank happen right in front of their eyes.

Former CEO Kerry Killinger was so selfish and dumb enough not to sell at $8 per share before turning to TPG and investors for money. He was too concerned about his own legacy and income that he forgot what his job functions were and who he wrote his paychecks. Oh and he was paid over $22 million in separation package.

And now Alan Fishman will get paid over $18 million dollars for three weeks of work? humm… since he failed to do his job as a CEO to secure the company... should he be compensated $18 millions?

Oh and Stephen Rotella (President and COO) is getting his $12 million plus package for doing what? Running WaMu into the grounds? This is on top of his millions in bonuses.

Are they serious? We need to stand up... Open up your eyes people... this just doesn’t happen over night.

Everyone in the executive team of WaMu should be held accountable along with the feds who led this take over without any recourse or consideration for the employees' retirements, public pensions and share holders.

2008 Sep 29 12:23 AM

[SportCarrera:]

This is the biggest underhanded deal in Wall Street history. Jamie Dimon is nothing more than a common crook and Sheila Bair is nothing but an ignorant lap dog.

Remember, they closed this deal in a hurry, just days before the bailout.

Karma Jamie...

2008 Dec 04 04:06 AM

[SportCarrera:]

You are so correct. Nobody will discuss it on CNBC, because they may lose an interview with Jamie Dimon.

CNBC helped lose thousands of pensions for WaMu employees, firefighters, police, teachers... They are lap dogs to Wall Street. Certainly not reporters.


On Sep 29 12:23 AM User 272175 wrote:

> This is a sad day for all of us shareholders and employees of WaMu...
> we were robbed blind by the feds and no one said or did anything.
> Chase, like other firms were circling like vultures, waiting for
> the feds to move in. They all knew what was going on... this was
> the plan from beginning on the week of the take over...
>
> The run on the bank was caused by the media and not one agency thought
> of regulating them or to set the record straight... they let the
> run on the bank happen right in front of their eyes.
>
> Former CEO Kerry Killinger was so selfish and dumb enough not to
> sell at $8 per share before turning to TPG and investors for money.
> He was too concerned about his own legacy and income that he forgot
> what his job functions were and who he wrote his paychecks. Oh and
> he was paid over $22 million in separation package.
>
> And now Alan Fishman will get paid over $18 million dollars for three
> weeks of work? humm… since he failed to do his job as a CEO to secure
> the company... should he be compensated $18 millions?
>
> Oh and Stephen Rotella (President and COO) is getting his $12 million
> plus package for doing what? Running WaMu into the grounds? This
> is on top of his millions in bonuses.
>
> Are they serious? We need to stand up... Open up your eyes people...
> this just doesn’t happen over night.
>
> Everyone in the executive team of WaMu should be held accountable
> along with the feds who led this take over without any recourse or
> consideration for the employees' retirements, public pensions and
> share holders.

2008 Dec 04 04:09 AM