Wachovia: Just the Plum Citigroup Needed

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Wachovia's fate as a takeover target was obvious after its board ousted Thompson this past June and replaced him with Robert Steel, a former Golden Sachs (GS) partner whose experience was not in consumer or commercial lending but in handling mergers as an investment banker. But Steel clearly didn't think it would come to this: As recently as Sept. 15, in an appearance on CNBC's Mad Money program, Steel delivered what appeared to be a convincing argument as to why Wachovia could weather the storm. Steel noted that, unlike the many banks that had originated or were now holding mortgages that had been bundled into bond-like securities, Wachovia was still holding the vast bulk of the $122 billion in option ARM mortgages that its Golden West subsidiary had made.

Playing for Time

So while many other banks had only two equally bad options with the mortgage-backed securities they held—sell at a loss, or mark down their value to the same low prices that similar bonds were fetching on Wall Street—Wachovia had the luxury of restructuring each of its loans in ways that would both enable the borrower to repay and give Wachovia a higher return on the loan. "We have lots of flexibility to figure out how to do this," Steel said. "We have lots of choices. So, basically, we're going to spend a lot of time."

But Steel didn't have time. While Wachovia management had argued that this flexibility could help it hold its losses to roughly 12% of Golden West's portfolio, Wall Street—and, more importantly, regulators—were increasingly convinced that the losses would be much higher: Shortly after JPMorgan Chase (JPM) took over Washington Mutual (WM), disclosures in regulatory filings led Wall Street analysts to assume that JPMorgan management was expecting that WaMu's portfolio of option ARMs would incur another 20% in losses beyond those that WaMu management had already recorded. Similarly, JPMorgan's filings convinced Wall Street analysts that the bank was expecting the loss rate on WaMu's home equity loans to top 30%. If those revised assumptions were extended to Wachovia, that meant that Steel & Co. could likely face another $15 billion in losses from the option ARMs alone—losses that would blow a huge hole in Wachovia's already depleted capital base.

That disclosure triggered a 31% plunge in Wachovia's stock on Sept. 26, to 9.45 a share, setting the stage for another one of the loss-of-confidence bank meltdowns that have become too common in recent weeks. And it convinced Steel to agree to a government-assisted buyout over the weekend.

Foust is chief of BusinessWeek's Atlanta bureau .