Reuters Edge

The next dominoes?

(The Big Money) Think of it as the head-fake economy. It goes like this: On Monday you spit out your coffee when you read in the morning paper that giant company A is going to go bust. On Tuesday you read that company A dodged a bullet and got bought by company B. Then on Wednesday morning company C implodes. Where did that come from? On Friday company B issues a press release that things are A-OK, which, for some reason you can’t fathom, sets off a chain of events that on Sunday night lead to the liquidation of company D. This is not a good state of affairs. So to help you stay ahead of tomorrow’s news and keep straight who else is going down while the world is still slapping its global forehead about Lehman Bros and AIG, here’s a short list of the likeliest casualties:

Think of it as the head-fake economy, reports The Big Money. REUTERS/Slate/Handout

Washington Mutual: Five months ago, we reported in Slate on how the subprime crisis was turning into a prime crisis, arguing that home prices would keep dropping. They have. We said the mortgage crisis would get much worse. It has. And we singled out two companies with the biggest exposure: Countrywide and Washington Mutual. Countrywide has now been absorbed by the Death Star ... oh, sorry, Ken Lewis’ Bank of America. And then there’s Washington Mutual. The last couple of days have made it look to the world as if the era of the investment banks is over and the day of the commercial banks is upon us. But there are commercial-bank failures to come, and candidate No. 1 appears to be Washington Mutual. It has a huge portfolio of disastrous option-ARM real-estate loans, on which most borrowers haven’t been paying enough to cover the interest, and will soon be hit with rising payments. As the country’s biggest savings-and-loan, it benefits from the relatively slacker supervision of the savings-and-loan regulatory body, the Office of Thrift Supervisiona small advantage that might delay, but not prevent, a crisis.

WaMu’s got it all: bad real estate loans, mortgage-backed securities (WaMu was the No. 5 mortgage-backed securities packager in 2007), downgrades from the bond rating agencieswith all this, the problems in its third-string credit-card operations are just a rounding error. The Big Money called to ask WaMu about some of this, and a spokesman promised by e-mail to send some information that would be “integral to the story.”

Eventually three press releases arrived. One, from September 11, expressed how disappointed WaMu was that Moody’s had downgraded its debt to “below investment grade” (translation: “junk”) and pointed out that other ratings agencies thought otherwise. That didn’t last long: the next press release sent out, four days later, responded to S&P’s decision to follow Moody’s lead. WaMu also points out that it doesn’t face losses from the Lehman bankruptcy. When companies start trying to draw your attention to the problems they don’t have, watch out. Maybe there’s a pony in there somewhere, but we’re still waiting to find it. So, in our view, this is the clear top choice for the big bank to go kaput. WaMu’s response: “To independently assert that WaMu is on the brink of failure or is the next likely candidate is both irresponsible and dangerous.”

Wachovia: The line on Wachovia was that, yes, it had massive exposure to losses in the California mortgage market, but this bank was different from all those with lousy mortgage loans. The mortgage giant that Wachovia bought, Golden West Financial, was supposed to be one of the best-run companies in the industry. As the creator of the infamous negative-amortization loan, Golden West specialized in big loans to well-off, financially sophisticated customers. Now, $100 billion of lost market capitalization later, it turns out that, well, it’s not so different after all. Yes, Golden West was better-run than many other mortgage issuers (they actually asked for documentation from their borrowers). But twenty years of uninterrupted ascent in the real-estate market will make anybody in the mortgage business look smart. Today, all bets are off.

Unlike some other players, Wachovia didn’t bundle and sell its mortgage loans. Wachovia spokesman Don Vechiarello points out that it gives Wachovia more flexibility to work out mortgages. That’s probably good for the borrowers, but it’s a different story for the shareholders: Wachovia’s portfolio of $122 billion in option ARM loanson which 60 percent of borrowers are making only the minimum paymentsis the biggest in the business. Sure, Wachovia has more ability to restructure the mortgages; it also has a lot more exposure to losses. Wachovia’s loans take longer to reset (10 years) than most competitors’; they also let borrowers go deeper into debt. By Vechiarello’s estimate, this makes them “more conservative.” Another take: they’ll just take longer to go bad.

Ambac: A few months ago, Ambac was the company that somehow managed to climb out of what looked like a certain and very rapid death spiral. The big insurer, which provides coverage to other financial institutions against the risk of their counterparties-like, say, Lehman-failing to meet their obligations, has had a tough year. Early this year, Ambac rejected a less-than-generous rescue offer from Warren Buffett.

Since then, a couple of things have changed. One is that the long-awaited collapse of major financial players is actually coming to pass. That’s likely to leave insurers Ambac and MBIA exposed to those I-can’t-believe-this-will-really-happen eventualities they insured against. (Ambac declined to comment for this story.) The other thing that’s changed is that Bailout Bingo is looking like a more and more inauspicious avocation. Early this y

ear, Ambac looked as if it was Too Important To Fail. But that was before Lehman, also pretty important, failed. And before Fannie and Freddie, the very models of Too Big To Fail, got bailed out in a way that left their shareholders with zip. Right now, who gets bailed out and how is something that depends on Treasury Secretary Hank Paulson’s mind and mood more than anything else, but any shareholders who think that Paulson will make them whole are dreaming.

Bonus Round: No, an implosion at Bank of America is not in the cards: the huge dreadnought of a bank can certainly take a lot of damage and still stay solvent. But Ken Lewis seems to have decided to take on a near quasi-government role in buying up deeply troubled institutions: first Countrywide, the nation’s biggest mortgage lender, and now Merrill Lynch. Maybe he sees something that other people don’t, but buying companies with unquantifiable and potentially almost bottomless liabilities is a high-risk way to grow. How big could the damage be? Big.