January 12, 2008

A What Were They Thinking Edition: Bank of America's Bad Deal

I found it surprising that Bank of America decided to buy Countrywide Financial. How much of BofA's decision was made because they had already invested a great deal into Countrywide and someone decided that they were in for a dime, so they needed to go for the dollar? And did they decide that they could turn the baby around if they were in control?

Let me tell you what I see. Countrywide is a tar pit and BofA is a dinosaur that has just gotten into the middle of it. Does BofA think there is real value under all the crappy mortgages Countrywide issued? Because it's pretty clear that a huge percentage of the loans Countrywide was issuing when it was getting so big were extremely questionable and risky. As I noted before, Countrywide was in the business of issuing terrible loans:

Here's what Countrywide Financial says about what would have been different if they had simply made a check on the borrower's income.

What's more, standards for making option ARMs were loosened starting in late 2004, when Wall Street firms began buying such loans in bulk to be converted into securities backed by the loan payments, Cecala said. Because lenders didn't have to keep the loans on their books, he said, they weren't too worried about the risk of losses.

As a result, loans of 90% or more of the home's value became the norm, up from a once-standard 80%. And many of the loans were made without verifying income or assets, even for borrowers who could easily have supplied that information -- an invitation for the borrower, loan officer or broker to fudge numbers, analysts say.

...Countrywide and other lenders tightened their lending standards last summer to ensure borrowers could afford loans after the interest rates adjusted upward.

Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.

That, it seems to me, is what BofA bought.

Here's Calculated Risk's take on the BofA purchase.

From Bloomberg: Shiller Says Bank of America May `Have Some Problems'

"There's a tendency for people to underappreciate the risk of the housing market,'' Shiller said. "I might have a lower valuation of Countrywide than Bank of America does.'' ... "Maybe Countrywide and Bank of America are going to have some problems going forward,'' he said. "When people see that their houses are worth a lot less than their mortgage balance, they have an incentive to default. The troubled mortgages that Countrywide already has will be followed by even more troubled ones.''

How far will prices fall? How many homeowners will be upside down? Will it become socially acceptable for upside down homeowners to walk way from their homes? What will be the impact on Countrywide (and BofA) if house prices fall 20%? If prices fall 30%? What if 10 million homeowners default over the next few years?

Those are some of the questions I'd be asking if I was at BofA.

Once more, here's what's going on with the securitized mortgages. The financiers have reaped the rewards from the housing bubble and the world will pay the bill.

Posted by Mary at January 12, 2008 10:52 AM | Economy | Technorati links |

OK, from what I've read, those loans were bundled off as debt instruments that were purchased by others -- IOW, banks have passed that bad debt onward, and people are not paying loans to the originating bank, but to someone else entirely...yes?

Gah, I have only done standard loans -- but at the moment I have no house loan, so I am far removed from this stuff (shut my 401(k) as well, and just in time as I see it).

Posted by: Scorpio at January 12, 2008 11:31 AM

This is just a wild guess, but maybe they are angling for a government bailout, kinda like with savings and loans in the 80s. It seems like they could argue that they are too big (10% of all loans or something) and important to the economy to be allowed to fail, so Uncle Sam will have to save them.

Posted by: sean at January 12, 2008 01:11 PM

Obama:Clintons politicizing race

Posted by: ccoaler at January 12, 2008 03:38 PM

Scorpio - you were very wise. I'm in a fixed mortgage, but probably very exposed in my 401k. Of course, I also know a lot of people who don't have much, if anything, saved for retirement - and I worry about what they will do when they want to retire.

sean, that's a very interesting theory - and quite plausible too. I'm not sure a bailout would be possible - the American economy was a lot healthier in the early 90s - and not nearly so deep in debt.

Posted by: Mary at January 12, 2008 04:31 PM