With today’s news, Washington Mutual (WAMU) is the latest on a long list of lenders to shut down its subprime division. Given WaMu’s decision I am beginning to liken subprime lending to the game hot potato. Over the past year the subprime crisis has resulted in increased volatility in the US markets, and seemingly every time the market believes it has correctly priced in the effects of the subprime mishap another lender goes public with massive write-downs and news that it is closing up shop and moving on. The latest to throw in the proverbial towel, Washington Mutual, stated that is will be laying off more then 3,000 workers as it shuts down 190 of its 335 home loan centers. Along with shutting down these centers, WaMu is planning to close nine of its call centers.

With this latest news coming from Washington Mutual, the largest savings and loan in the US, it makes me ask a few questions. I wrote before that I believed that the subprime mess was getting worse and I am not shocked to see companies continuing to run from the subprime loan industry. The main question that I am now asking myself is ‘Who is going to be left without a chair when the music stops?’ We have seen many lenders go bankrupt over the past two years, and if subprime is to get worse who will be the next victim?
Just last week, H&R Block (HRB) had to back out of its agreement to sell its mortgage lending arm, Option One, to Cerberus Capital for $1 billion. Of course, H&R Block never should have been in the mortgage lending business to begin with, as Chairman Richard Breeden admitted, saying “the principal business of H&R Block is helping millions of individuals and thousands of businesses meet their needs in connection with tax planning and filing tax returns, not making subprime mortgage loans.” Without the ability to sell Option One, H&R Block will be taking tens of millions in charges, just like Washington Mutual. Again, sub-prime has deteriorated to the point where one bad announcement just seems to be a precursor for another; who is next now?

The above picture shows the loans that were securitized over this past year are defaulting at a much higher rate then the loans securitized in 2005 and 2006. This means that the subprime mess is going to get worse before it gets better. For this reason, Washington Mutual is likely making a wise decision to cut its loses and leave the subprime lending area. This move will cut costs by $140 million in the fourth quarter alone. Leaving the subprime market is a wise decision as investments remain risky with defaults continuing to rise, and this has exposed the difficulties the ratings agencies (like Moody’s - MCO) have properly assessing and disseminating the risks related to mortgage-backed securities. With securities unable to be easily valued this market has become a minefield for potential investors. Given this fact, it is better for Washington Mutual to take its lumps now instead of possible suffering further losses down the road. What subprime lenders will be able to make it through and who gets stuck with the hot potato? We will have to watch as this drama continues to unfold to find the answer to that question.

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