With Countrwide "Contained," Is Washington Mutual Next?

 |  Includes: CFC, WMIH
by: TraderMark

Miracles do happen.

The Plunge Protection Team er, The President's Working Group on Financial Markets meets, and not even a week later we have a bid for Countrywide (CFC). The timing is almost amazing, isn't it? Oh, to be the fly on the wall during that conversation.

I wrote this on a message board Thursday night:

Call me a conspirasist but I think the govt is doing this. Citi can't do it, so BAC is 2nd largest, absorb this piece of (edited for language! haha) and we'll make sure you are ok on the other side.

Now we need to find someone to buy WaMu and then we have about 40% of the U.S. mortgage market "saved."

• • •

Here is the reality, a Republican administration does not want to be seen bailing out a leading financial institution with tax dollars. Additionally, a CFC bankruptcy would of caused serious panic as I believe it handles about 20% of the country's mortgages. It would kill confidence. Rightly or wrongly, the sharks have been circling Countrywide, and many bankruptcies are accelerated by lack of confidence. Vendors stop sending product to a manufacturer because they are afraid of not getting paid back, bank lines of credit dry up, and it feeds on itself. This is the scenario that has been playing out with Countrywide.

The facts on the ground, are that 7% of Countrywide loans are now delinquent, which is up from 5% a year ago, and foreclosures have almost doubled. And that's coming off a "great" 2007 in the economy. These don't sound like huge numbers, but again we are just ENTERING the real credit mess, most of these two-year ARMs are just now jumping (and will be continuing to do so throughout 2008). People will try their best to pay for a few quarters (or use credit cards to pay mortgages), but eventually, they will succumb, and lose their homes.

The height of defaults will probably hit about a year from now and into 2009. Countrywide won't last that long. 9%, 11%, and 13% delinquency rates a year from now would be a nail in Countrywide's coffin. They are dependent on new funding and its lines of credit would dry up. (One could argue that the company still has its bank deposits, but did you see the lines at Northern Rock once panic hits?) ["Northern Rock Drops 30% Today"]

So what do we have here instead? We have one of our stronger banks, Bank of America (NYSE:BAC) buying a company on life support, and with the implicit backing of the government. Trust me, the government will be helping Bank of America on the back end, "behind closed doors," because these loans are like asbestos. They have huge future unknown liabilities. Would anyone buy a company with asbestos exposure in the 1990s, knowing the huge future liabilities? No. But if you have the government doing a behind the scenes bailout for you, it gives you entry into the mortgage market, a 20% share, and you have a balance sheet that is good enough to live through the next few years, and then when we come out of this in 3-4 years you have a dominant position in a great long-term business (mortgages).

Alone, Countrywide wouldn't make it through another year, not to mention the 3-4 years. Keep in mind that a year ago, Bank of America was in talks to potentially acquire CFC when it was in the $40s. And at that time they paid around $2 billion when it was around $18 in August. So to get the franchise for under $7, with a $4 billion price tag is nothing. $4 billion? In the financial world these days, companies write that amount off every month.

The other dog is Washington Mutual (NYSE:WM). I am sure the same arrangement will be made for an implicit behind the scenes, government bailout of whomever takes over WM. It won't be Citigroup (NYSE:C) since the company itself is in such a bad situation, but it will be one of the top 5-7 banks like a Wells Fargo (NYSE:WFC) type who actually ran its business reasonably well (again, it's all relative), and has no SIVs or off-balance sheet junk. And in the long run it will strengthen its business just like the situation with Bank of America. But you need to be strong enough financially to weather the next 1-2 years to get out "the other side." Maybe it's next week, maybe it's next month, but within 6 months I would expect WM to be taken out.

As investors we won't have to hear about this issue day in, and day out. From that perspective, it's 'containable. About 35%+ of our mortgage market will go from "weak hands" to "strong hands" (those who can handle asbestos exposure for the next few years), and the needed write downs on this portfolio can continue in the background - and your U.S. tax dollars can make sure it all works out well in the end.

From a stock market perspective, this is a win as these 2 dogs won't be the underpinnings of angst on a daily basis. From a "free market" perspective, it's laughable.