5) What kind of risks that trigger the financial distress for the institution? Bank level risk? Market level risk?

Washington Mutual Bank’s management stated in its annual report: the company is exposed to four major categories of risk: credit, liquidity, market, and operational risk (1). Operational risk is exposed to a high level, especially when the WaMu was too aggressive in its selling Mortgage Backed Security and massive expansion within a short period. While the relaxation of lending standards by WaMu, such as the underwriting of loans with high loan-to-value ratios, high loan-to-income ratios, little or no documentation of income, and so on amplify the financial distress (Robertson, 2011)(2). The nature of the loan business was the credit risk that was accelerated to an extreme risky level at Washington Mutual’s loan factory, underlying poor credit standards, lingering underwriting system and ambitious sales target. The credit risk that triggers the crisis included: highly risky lending strategies, poor lending practices, steering borrowers to high risk loans, excessive loan error and exception rates, failure of OTS to enforce corrective actions, inaccurate rating models used by CRA’s market rating.
The most significant risk that triggers the financial distress for Washinton Mutual is Market Risk where the primary market risk that WaMu is exposed is interest rate risk. The Washington Mutual began to engage in risk taking activities and constantly dominated the MBS and CDO markets from 2004 until the Crisis. The interest rate risk triggers the crisis on June 29, 2006, when the FED had increased the federal funds rate 25 basis points to 5.25 percent to keep the funds rate at the level for the remainder of 2006. With interest rates rising and the deflation of housing price made mortgage debt higher than the value of the property, causing many homeowners becomes negative equity and the end of the easy money in the residential real estate market. With inflated income stated on the loan applications, loan borrowers faced with the reality that they had never anticipated: they were no longer afford to pay interest and installment. Washington Mutual as the representatives of the CDOS foreclosed on the loans as intended and placed the properties up for auction. However, given the large number of properties that appearing on the property market at once, housing supply exceeded demand and the market values of these properties consequently began to fall. In 2007, WaMu recorded a $67 million loss and shut down its sub-prime lending unit. When the outbreak of loan defaults, housing foreclosure spread out national wide for a long period enough, the economic and financial systems became weakening, leading to the U.S. financial crisis and causing immense collapses of financial institution and the U.S. banking system. These incidents presented how the market risks affect businesses and as well as the national as the whole. In that lousy financial picture, clients were fearful of losing Washington Mutual Bank’s resources and capital, put the company at a high liquidity risk and forced to bankruptcy. Washington Mutual Bank may not anticipate a badly-ever economic scenario can be happened when all business risks occur simultaneously and at the magnitude of a tsunami that eventually swept out the company in an instant.

1. http://getfilings.com/o0001047469-05-014026.html
2. https://www.occ.treas.gov/publications/publications-by-type/occ-working-papers/2012-2009/wp2011-1.pdf
3. https://core.ac.uk/download/pdf/6649126.pdf