SAN FRANCISCO (MarketWatch) -- In the largest bank failure in U.S. history, Washington Mutual Inc., with about $310 billion in assets, succumbed Thursday to the fallout from the subprime mortgage crisis, was seized by federal regulators and rapidly acquired by J.P. Morgan Chase for $1.9 billion.

The federal Office of Thrift Supervision said it closed WaMu WM, -0.55% on Thursday and appointed the Federal Deposit Insurance Corp. as receiver. The FDIC in turn conducted the bidding process that led to the purchase by J.P. Morgan JPM, -0.84% .

"With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business," the Office of Thrift Supervision said in a press release posted on its Web site.

The move, coming on a Thursday, highlighted the severity of the credit crisis, coming even as efforts to agree on a financial rescue bill faltered in Washington. See related story.

Continental Illinois National Bank & Trust was, for more than 20 years, the largest bank failure in U.S. history. It had $40 billion of assets when it failed in 1984.

Federal officials said WaMu, which has some $900 billion in customer deposits, would be open for business Friday.

WaMu, long one of the nation's largest mortgage lenders, was hit hard by the subprime crisis that has widened to threaten U.S. financial markets and led to the current crisis and the federal proposal to stabilize financial markets with a $700 billion plan to buy up bad debt.

WaMu had lost $16.7 billion in deposits since Sept. 15, according to the Office of Thrift Supervision, and had been seeking a buyer over the past week.

Over the last three quarters, the firm's losses totaled more than $6 billion as it wrote down billions of dollars of bad loans.

Its stock price had plummeted some 95% to its close of $1.69 a share Thursday. On Wednesday, a Standard & Poor's ratings downgrade further pushed the bank toward collapse.

Option ARMs and other risky loans

Washington Mutual's downfall was hastened by the collapse in real estate prices and exacerbated by its aggressive lending practices.

WaMu, as the company is commonly known, was the second biggest originator of home loans called "Option ARMs," which were marketed to borrowers via low introductory rates and included various payment options.

Those loans often included the option to pay only interest, which caused the borrowers debt to grow with each payment, becoming negative amortization loans.

When housing prices began to fall just at the time rates were adjusting higher on those loans, borrowers began defaulting at alarming rates, leading to big losses for WaMu and others who had extended the credit or purchased securities based on the credits.

Since the subprime mortgage crisis began last year, the widespread credit crunch and economic malaise has claimed numerous victims, including large Wall Street brokerages such as Lehman Brothers Holdings Inc. LEHMQ, and insurance giant American International Group Inc. AIG, -1.23% .

The economic woes have also resulted in the failure of 12 banks so far this year.

Unlike those bank failures, however, J.P. Morgan's purchase of Washington Mutual's operations isn't expected to affect the FDIC's insurance fund, The Wall Street Journal reported.

WaMu debt, equity not included, probably worthless

J.P. Morgan said the purchase included all of WaMu's deposits, assets and some liabilities. It said the purchase excluded senior unsecured debt, subordinated debt, and preferred stock of Washington Mutual's banks. J.P. Morgan said it would not be acquiring any assets or liabilities of the bank's holding company.

"We believe the remaining value of the holding company is negative, eliminating value to the common and preferred shareholders and most of the debt holders," analysts at Keefe Bruyette & Woods said in a research report Friday.

WaMu shares fell more than 90% on Friday.

David Bonderman's private equity firm TPG, which had led a consortium making a $7 billion investment in Washington Mutual, will likely lose most of their investment.

The Journal earlier reported that other potential suitors for Washington Mutual have included Citigroup Inc. C, -2.12% , Wells Fargo & Co. WFC, -2.35% , and private equity firms Carlyle Group and Blackstone Group BX, +0.09% .

However, potential suitors including Spain's Banco Santander STD, -4.33% and Toronto-Dominion Bank of Canada TD, -1.43% showed initial interest but then cooled to the idea of striking a deal, according to the Journal.

Swallowing a giant

J.P. Morgan said it is raising $8 billion in fresh capital via a common stock sale, and expects to post $1.5 billion in pretax merger costs, but expects the WaMu acquisition to add more than 50 cents per share in earnings in 2009 and bring annual pretax cost savings of about $1.5 billion by 2010.

It said it will convert WaMu's consumer banking, home lending and credit card businesses to the Chase brand over the next two years.

The move will leave the buyer with about $900 billion in customer deposits and make it number one in that category. The WaMu branches it is buying will make J.P. Morgan the second largest in the U.S. in that category, with 5,400 branches in 23 states reaching 42% of the population.

As of June 30, Seattle-based WaMu had $307.2 billion in assets, 43,198 employees, and 2,239 retail offices in 15 states.