Vision Credit Education, Inc.

We all know that Washington Mutual got into financial trouble as a result of massive subprime mortgage losses, and that many of these subprime loans originated in the 2004-2005 years. However, this is only half of the story.

Real Money Drain Was Providian

Washington Mutual acquired Providian in 2005 for $6.5 billion. It gained an estimated 10 million card holders, of which it also marketed profitable credit insurance and subprime mortgages.

However, there was an inherent problem with the Providian customer base. This is what caused the failure of Providian in the first place.

Providian was a master at marketing expensive, fee-laden credit cards to risky borrowers. They found that there was an entire class of consumers that had been up until then left out of credit card marketing.

Nevermind that many of these consumers could not afford the high cost of credit associated with these products. Providian was able to charge substantially more fees on their cards than what other card issuers typically did. The reason was that so many of their cardholders were low wage earners or had other financial difficulties.

What WaMu did not count on was the double whammy of credit card defaults and foreclosures by its customers. Even though they unloaded many of their mortgages onto Fannie Mae, they still had to bear the full loss of their credit card defaults.

WaMu’s clients had a higher than average rate of default for both credit cards and mortgage loans. It all stemmed from the targeting of poorer families by Providian prior to the 2005 sale to WaMu.

As a result, WaMu fell victim to massive losses because of its financially troubled customer base. The bank’s troubled balance sheet led to seizure of the bank by federal regulators. The entire process culminated with the sale of WaMu to JPMorgan Chase.

Everyone blames the subprime losses. Its true that these are to blame. However, the troubled makeup of the Providian customer base poisoned the Washington Mutual portfolio.

Now this base becomes part of JPMorgan Chase, which will have to find a way to stem losses and begin profiting from these customers. As an acknowledgment of such expected losses, JPMorgan Chase will immediately record a $31 billion reduction in the book value of these loans.

Still, JPMorgan Chase could benefit from this transaction. The benefit will not come from the troubled customer base however. The main benefit is the expansion of its banking operations to 5,400 branches in 23 states.