Bank of America Buys Countrywide - Who Gains and Loses?

In general, I think it is good news for CFC (of course), for homeowners, for the Fed, for the federal government, local state and city governments, semi-government agencies such as Fannie Mae and Freddie Mac, good for taxpayers like us - but bad news for BAC.

As one reader pointed out in his comment, there has been wide speculation for the last several months that the government is behind the scene to urge (or push? or beg?) BAC to rescue CFC. The government would not allow CFC to fail, since it would create a domino effect much worse than the S&L crisis and LTCM. The failure of CFC would have triggered many counterparties conducting OTC derivative trades with CFC to fail, which would have brought the whole OTC derivative market including all large investment banks into their knees, similar to the LTCM situation in 1998.

The failure of CFC would also transfer all the credit risks to semi-government agencies of Fannie Mae and Freddie Mac, which would force Fed and federal government to bail them out by using taxpayer's money, similar to the S&L crisis in the late 1980s - except this time the amount is probably 10 times larger. I don't even need to mention what that would do to other fixed income products, the general credit market, equity market and the US economy.

As I indicated in many of my previous blog posts, I think 2008 is the year banks will face a lot of legal challenges. We see today that the city of Cleveland has filed lending practice suits to 21 banks including BAC and CFC. We should see a lot more of this type of suits being filed by both local and state attorney generals' offices for the whole year. We should also see number of suits from homeowners facing foreclosure growing to sky high this year. If CFC files for bankruptcy, this kind of law suit would not be able to be compensated monetarily even if they win. However, by BAC stepping in buying CFC, it creates a deep pocket situation that all the suits now will target BAC.

It is similar to a drug from a small single-drug biotech going bad - the patients have less incentive to sue since even if they win the biotech company would just go into bankruptcy and patients and their vulture lawyers would get nothing in return. However, if this small biotech gets bought by a big pharma right before the problem surfaces, good luck to the big pharma. It is guaranteed that you would see a flood of lawsuits from everyone who has taken just one pill of this drug in their whole life.

BAC should just forget about the $2B bad investment in CFC last August. Adding to losing position is usually not a good trading strategy, not even considering all the legal ramifications and their huge liabilities. But it is great news for many people at the other side of the trade with CFC and all levels of government, with BAC now catching the falling knife and holding the bag for many years to come until the deep pocket becomes much shallower.

Comments

[Celticpole]

Deep pockets or not, I don't think that anybody at BofA will ever be worried about CFC repercussions via "vulture lawyers". Anyone who's ever dealt with BofA and their parting with money may know what I'm talking about. The great-great grand vulture children lawyers will still probably be getting a run-around on the BofA phone lines. Please press cube root of pi for ancient Klingon. It would be fun to finally see a behemoth like BofA squish some of these legal lottery adherents who create nothing but rising costs for the rest of us. I say: All the way, BofA!

[oldtimer]

A truly great side of the mortgage mess (at least as far as Cleveland, Ohio is concerned is the fate of many of the homes here which are in foreclosure. As soon as these houses are vacated, they are cannibalized by some of the local "entrepreneurs&qu... for everything that can be sold for scrap. (siding, windows, plumbing, wiring and even windows and doors.) Guess you could call it evaporating equity!! The end result is a derelict house which is an attractive nuisance and blight on property values and which can never be rehabilitated. Of course, the public will be expected to clean up the mess by tearing down the housing or it can be left standing to attract rats, addicts, gangs to the further detriment of the neighborhood. And you wonder why there are lawsuits.

[User 139263]

I agree with the ramifications of letting CFC fail ---- but please Oh poor BAC - they were forced to pickup a company for nearly nothing. They expand their franchise; have govt support in achieving a deposit balance they otherwise would be prohibited from; probably have govt support in addressing an portfolio issues.... It's as if the value of CFC at 4-5/share or less is the same value of the company if it had the liquidity of BAC..... give me a break... they benefit from being only player that can do the transaction.

[Shanky]

It is definitely a gamble for BoA. However, since the whole deal was backed by the Fed and other govt organizations would otherwise have to face the wrath of Subprime mess, will definitely bail out BoA of hardships. In all I think its a very good deal for BoA.

[blah-blah]

I agree with the other posters, anyway you look at it - it's a good deal for BAC most of all. They get the lucrative servicing business and gov't backing all for pennies of what it's worth.

Once again Thomas Tan has proven that he knows nothing

[Spanish Moss]

I believe you are spot on. Of course, I would rather you were wrong, but I'm not at all sure you are.

On the Cleveland lawsuits, I think it would be nice to see the entities Cleveland has sued counter sue Cleveland for not providing police and fire protection to the vacant properties in order to perserve equity for the borrowers (yes, under Durand, lenders must return equity to borrowers). No equity you say, then also sue the borrowers, sellers, realtors, (oops Realtors) and appraisers for over valuing the properties securing the loans.

Now I'm on my soapbox, but let's not allow the plaintiff's bar to add insult to injury by driving up the cost of everything in this country. Insurance, housing, pharmacuticals, health care, cigarettes, on and on ad nauseum...

Thanks, I feel better now!