The First Panic

In early July 2008, hundreds of people lined up outside the headquarters of IndyMac Bank in Pasadena, Calif. News reports had made clear that IndyMac had a large exposure to troubled subprime loans. Fearing the bank was on the verge of failure, customers were pulling out their money. The line stretched down the block. That image, which appeared on newspaper front pages and TV stations nationwide, depicted the first major bank run since the savings-and-loan crisis in the 1980s.

Two blocks away, managers at a large, white-columned WaMu branch watched the commotion. Soon, their own customers began asking, “Is my money safe?”

On the evening of Friday, July 11, just after the FDIC seized IndyMac, a top WaMu retail bank executive in Seattle sent an email to other retail bank executives across the company with a simple question: “IndyMac has failed—How are we going to respond?”

Through a flurry of sometimes heated emails, managers across WaMu’s network of 2,239 branches worked out a rough plan. WaMu’s deposit team would forecast the potential size of a run, based on daily data about cash outflows. Branch managers would try to reassure anxious customers. Tellers, who usually just cashed checks and dispensed rolls of quarters, now would recite details to show WaMu had more than enough money to meet regulatory minimums.

“We had tellers who knew our capital ratios and our liquidity ratios,” said George Kaye, who managed more than 200 WaMu branches in Southern California. “We were educating everyone.”

Despite these efforts, WaMu suffered a $9.4 billion run—seven times bigger than IndyMac’s. Southern California became the epicenter, although customers all around the country pulled out cash. Unlike IndyMac, however, WaMu executives kept the five-alarm fire under wraps. No lines formed down the block. No TV cameras splashed the news. Shareholders never knew, either. This first run happened after the start of the third quarter, and WaMu collapsed three business days before the quarter ended, following the second bank run. It never reported those financial results.

The Moody’s Meeting

At the end of August, Rotella and WaMu Treasurer Robert Williams boarded a leased private jet in Seattle and flew to meet with Moody’s Investors Service in New York. Typically, WaMu executives met with Moody’s senior credit officer, Craig Emrick. This time, however, the powerful rating agency greeted the WaMu executives with a team of people, an ominous sign.

“We don’t know exactly why that was,” said Peter Freilinger, WaMu’s assistant treasurer who flew out separately to attend the meeting. “Moody’s might have felt that the action was so important that they wanted everyone to hear the facts before they did anything.”

The bank run had calmed in August. To entice customers to make deposits, WaMu offered a special certificate of deposit paying 5 percent interest—extremely high at the time. It worked, and new money flowed in. But now, at Moody’s, WaMu executives had to face another challenge: the repercussions of the bank’s foray into risky mortgage lending.

Under former CEO Kerry Killinger, WaMu had written subprime and option-ARM loans to hundreds of thousands of home buyers with shaky credit, particularly in California. The loans generated healthy fees, and the bank could offload the risk by selling them to firms that turned them into mortgage-backed securities. But when the market for those securities crashed along with the housing market in mid-2007 and borrowers were foreclosed on, WaMu and other banks were left holding large numbers of bad loans. WaMu all but stopped writing these sorts of loans in late 2007, but it was too late. At the end of June 2008, there were still $69 billion of them on WaMu’s books—58 percent of all its home loans.

At Moody’s office, a few steps from Ground Zero, Rotella and other WaMu executives squared off across a conference table from the rating agency’s team. Led by Emrick, the analysts fired questions for an hour and a half, Freilinger said. Is the high-priced CD really bringing in stable customers? Does WaMu have any further strategy to bring in deposits? How is the bank dealing with its ailing mortgages and home equity lines of credit?

Rotella, who usually sent lower-level exectives to these meetings, tried to convince the analysts that WaMu had sufficent capital and deposits, despite the July bank run. Helped by a $7.2 billion private equity infusion in the spring of 2008, WaMu was easily in the range of a “well-capitalized” institution, by regulatory standards. Still, its recent second-quarter loss totaled $3.3 billion and it had just set aside $5.9 billion to cover bad loans.

The stakes of the meeting were high. A Moody’s downgrade would tag WaMu as a poor credit risk, making it difficult for the bank to borrow funds and further eroding public confidence. Moody’s declined to comment on the meeting.

Moody’s wouldn’t make a decision for several days. But the analysts asked pointed questions and didn’t joke. They sat with arms crossed and faces sternly set. WaMu executives left feeling they had failed to convince the agency of the bank’s health.