Voros: WaMu failed because it retained risk - Inside Bay Area

Their competitors passed the bad loans, or at least the risk of them, on to unsuspecting investors and us, the taxpayers. But WaMu said "the buck stops here," and took responsibility for the risk. Result: WaMu is dead.

Inside Bay Area:

... But what did WaMu do that wiped out its very existence while others like Chase and San Francisco-based Wells Fargo seemingly avoided the same mortal wounds?

WaMu assumed the risk of its mortgages, choosing to keep a large portion of the loans they made as well as servicing nearly $500 billion in mortgages from other banks. It all seems logical. Bank aggressively markets loans, amasses hundreds of billions in mortgage "assets'' only to watch those values evaporate as the housing industry experiences its worst collapse since the Great Depression. Bank goes under.

Over on the other side of the fence, Chase and Wells Fargo approached things differently. While the two banks also worked hard to build their mortgage businesses, they did not have as low a lending standard as WaMu, nor did they keep as many loans as they made, as WaMu did.

While avoiding the subprime pitfalls certainly played a major role for Wells Fargo and Chase, the securitization of their loan portfolios proved to be a lifesaving hedge and removed risk quicker than you can say "FDIC seizure.''

And here lies the heart of our current economic problems. The proliferation of bad debt was fueled by the repackaging of loans, primarily mortgages, into investment vehicles commonly referred to as mortgage-backed securities, which greatly dilutes risk.

Typically, 200 to 300 mortgages would be pooled into one portfolio. To qualify for the pool, a mortgage would need to have only the first three months of payments made. A formula — which few humans could understand — for creating value to the portfolio is applied and then sent to Wall Street to be sold in shares. By pooling the mortgages, nonperforming or underperforming mortgages are absorbed by the large majority of performing mortgages, in a perfect world.

We have seen what happens when mortgages in the portfolio fail at such a high rate that it poisons the portfolio, creating a toxic asset that is worth pennies on the dollar and that no one except Uncle Sam will touch.

For WaMu, their entire mortgage portfolio became toxic, sending it to its grave. Meanwhile, other banks that worked frantically to securitize their mortgages couldn't care less whether the loans they originated performed or not, because that was someone else's problem — which is now the taxpayer's $3 trillion problem.