The Housing Chronicles Blog: BofA a White Knight for banking regulators?

Saturday, January 12, 2008

BofA a White Knight for banking regulators?

In his latest column, Lou Barnes again pulls no punches about the real reasons behind the Bank of America-Countrywide deal, and argues that long-term mortgage rates will rise as the Fed lowers short-term borrowing costs:

BofA's acquisition has all the fingerprints of a liquidation, one in the interests of banking regulators to avoid the collateral scramble and fire sale inevitable upon the instant of bankruptcy. The idiot stock market soared on the acquisition news on Thursday, and reality dawned today: BofA's stock is down, its credit-risk premium up, and Moody's is considering a downgrade.

So, what's the benefit of this deal to BofA, good money after the bonehead $2 billion infusion into Countrywide last September? First, good will and blessings from the whole regulatory apparatus. No other institution had the strength left to absorb the Countrywide wreck, and good deeds beget future favors. BofA's September infusion may have bought it control, but system conditions have since deteriorated so badly that it need not have paid a dime -- regulators would have come to call, hats in hands.

Deconstruct the deal: The prize inside Countrywide is its loan servicing portfolio; right now a migraine, but $1.4 trillion in mortgage customers is a huge base of clients who instantly become BofA pigeons. Loan servicing has a common market value in excess of 1.5 percent; even if this pool is discounted for bulk and trouble to 1 percent, that's $14 billion in value.

BofA is paying $4 billion for the overall wreck, meaning Countrywide -- minus its servicing portfolio -- has a negative value of at least minus $10 billion. Its dinky "bank" (really an S&L, easier regulation) is leveraged to the eyeballs and probably has a net-loss portfolio; and the insurance and securities and other tacked-on businesses have value only if originations run hot (not).

The massive origination arm has negative value also. Absent the fee-rich subprime and option-ARM game, Countrywide is a low-margin, commodity Fannie-Freddie shop just like the rest of us. BofA needs another brand name like a moose needs a hat rack, and assumes future losses from litigation, portfolio and downsizing. A lot of branch landlords are going to have some re-leasing to do.

And about about Bernanke?

Bernanke looked haggard. He has studied class-A financial crises his whole life, but leading the Western banking system out of one is a different matter. The speech is an excellent read. He is under no illusions: "... The financial system remains fragile" [!!]. Long sentence, third paragraph from the end, after many promises to intervene to save the economy: [compressed] "However ... unmoored inflation or eroded Fed credibility could reduce the Fed's ability to counter shortfalls in economic growth."

He is stuck: slash rates and take the inflation risk? Or fight inflation and let the economy fend for itself -- and become the most hated man in America?

If he cuts dramatically to save the economy, look for mortgage rates to rise. That's the largest probability, now, as political pressure on him is too strong to withstand.

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