The credit crunch has seen the biggest bank failure in American history this morning with the country’s largest savings and loan, Washington Mutual, failing and its $US310 billion in assets and $US182 billion in deposits seized by bank regulators and sold.

JPMorgan Chase, which bailed out Bear Stearns with a $US29 billion Fed loan in March, paid just $US1.9 billion for the assets, loans and some of the bank’s 2,300 branches across America.

US and international financial circles have been full of talk of its plunge towards failure. The shares fell 25% on Wall Street overnight to just $US1.69, with hundreds of millions sold (and bought by some optimists who have lost all) as holders wanted to quit the stock at any price.

At $US1.69 Washington Mutual (WaMu, as it was also known) had a value of around $US2.9 billion, so JP Morgan has gotten it at a knockdown price. According to US brokers, the company had a book value at the end of June of $US18.4 billion.

The holders of the company’s shares and various forms of debt were wiped out. Regulators said there were no costs to the deposit fund that insures bank deposits up to $100,000 each. Retail deposits, estimated at $US182 billion at June 30, loans and some of the buildings have been bought by JPMorgan, plus the $US310 billion in deposits.

Treasury Secretary Henry Paulson’s $US700 billion plan to prop up the US banking and finance sectors by buying distressed mortgages wasn’t enough to save the company. It couldn’t hang on.

WaMu, as it’s known in the US, has been on the market for over a week, but no one from a long list of candidates would buy it,

The failure of Lehman Brothers almost two weeks ago will be a bigger event, but it was not a regulated bank like Washington Mutual.

The company was seized by regulators around 7 pm East Coast time in the US, about 9 am Sydney time and the assets and deposits sold to JPMorgan, according to a press release on the FDIC’s website.

JPMorgan Chase acquired the banking operations of Washington Mutual Bank in a transaction facilitated by the Federal Deposit Insurance Corporation. All depositors are fully protected and there will be no cost to the Deposit Insurance Fund.

JPMorgan Chase acquired the assets, assumed the qualified financial contracts and made a payment of $1.9 billion. Claims by equity, subordinated and senior debt holders were not acquired.

WaMu’s balance sheet and the payment paid by JPMorgan Chase allowed a transaction in which neither the uninsured depositors nor the insurance fund absorbed any losses.

Washington Mutual Bank also has a subsidiary, Washington Mutual FSB, Park City, Utah. They have combined assets of $307 billion and total deposits of $188 billion.

The Seattle based WaMu collapsed after its credit rating was cut to one notch above the lowest level of “junk” by rating groups over the past two weeks.

It was facing an estimated $US19 billion in losses from subprime related and other mortgages over the next 30 months, according to analysts. It had lost $US6.3 billion over the past nine months as subprime losses mounted.

The company rejected an over offer from JPMorgan in May at a reported $US4 a share: today’s buy is a fraction of that as the shareholders and bondholders get nothing.

The previous biggest regulated banking failure in the US was Continental Illinois. It failed and was taken over in 1984 and at the time it had $US40 billion (an estimated $82-plus billion in 2008 dollars) when it tanked.

The collapse of Washington Mutual means big losses for investors, including the aggressive US buyout group, TPG, which led an investor group that bought a minority stake in WaMu in April, with a $US7 billion capital injection: that’s been lost.

We are lucky TPG and its mates at Macquarie Bank and in the airline’s management, didn’t get hold of Qantas last year.

What does it mean for Australian banks?

The growing problems at Washington Mutual illustrate why Australian banks have been maintaining record balances in their overnight liquidity holdings at the Reserve Bank.

They, like banks around the world, were terrified by the failure of Lehman Brothers, even though not directly impacted to any degree, shocked by the forced sale of Merrill Lynch and then further shocked by the takeover of AIG.

Its why banks have boosted cash holdings at their central banks: in London there’s billions of pounds of cash sitting in low yielding accounts at the Bank of England, just as our banks left a record $A7.4 billion with the reserve Bank overnight.

They are also scared that there might be a sudden contraction in credit and liquidity if the Paulson plan should fail. That’s why their holdings left in the Exchange Settlement Accounts at the RBA over the weekend will be substantial.

There is a very real chance the Paulson plan will still be not firmed up by the start of trading Monday morning and the failure of Washington Mutual will only intensify those concerns.

Figures from the RBA’s market operations show that the banks and other institutions authorised to deal with the central bank left a total of $7.4 billion in their exchange settlement accounts last night rather than lend the surplus overnight to one another.

The Exchange Settlement Accounts are designed to accommodate overnight liquidity for each bank and institution to allow for a possible larger than expected cash call in overnight settlements or in the event of a ‘liquidity event’ such as the failure of Lehman Brothers or problems with a bank like Bear Stearns.

The banks are taking less than the cash rate from the RBA to leave the cash in the ESAs: the rate is 6.7%, but that is preferred to the possibility of being stuck in a market frozen, or in a collapsed company

The Reserve Bank held its first auction of $US10 billion swapped with the Fed in Sydney today and all greenbacks were sold at a rates ranging from a high of 3.16% to a low of 2.45%. The funds were for 28 days and the interest rates relate to a margin above the US rates.