B of A, Another Superman?

This, being Wednesday, would normally be a full report but there is only one thing on the schedule this evening and that is Bank of America’s “rescue” of Countrywide Financial (CFC) announced in after hours trading this evening. In a bold move, even for Superman, B of A has decided to invest $2 billion in CFC, even though B of A decided many years ago not to get involved with subprime loans. For reference, please refer to the front page of the WSJ on Thursday morning to see the article we are reading this evening.

There are so many problems in the mortgage world that we just can’t mention them all here. CFC’s problems have become more noticeable over the past few weeks due to the fact that it was near bankruptcy. Why would a company be on the verge of bankruptcy? Well, CFC’s financing is mainly done in the Commercial paper market which is the basis for quite a few money market fund assets. Over the past few days, as we have mentioned here, there has been a major left turn moving assets from risky assets to much safer Treasury securities. When this happened, the primary funding source for CFC dried up.

One thing we would like to mention is the falloff in CFC’s stock price. Take a look (over at the big charts link to the left) at the stock price performance over the past year. You will see that it has been falling from the 45 range early this year. CFC did drop with the general mortgage woes back in late February but managed to recoup most of those losses by May when it was trading at a high of 42. Since then the stock has been drifting lower until hitting a low last week at 15—this does look like some fear and panic selling late last week.

Then, enter the Fed: The rumor of a rate cut on Thursday afternoon last week causes a rebound in financial stocks, particularly CFC. This bounce moves the stock from 15 Thursday afternoon to nearly 24 on Friday morning, a 60% move up in about two trading hours. The move by the Fed did cause some investors to chase the Treasury market shifting funds away from the likes of CFC. Now, the Fed needs to beg the banks to start borrowing money from the Fed’s discount window, and several do. Still, there is some trepidation among market participants that the mortgage industry needs some help (No Kidding).

Enter Bank of America: As CFC was being downgraded by many, there was another game going on behind closed doors to seek a way to calm markets. Tonight, the big announcement came; B of A was stepping in to provide some funding for CFC. The market now feels much better and is rallying as we write this. Apparently, $2 billion from B of A is enough to help CFC even after the mortgage company took advantage of $11.5 billion in funding over the past week from a consortium of 40 banks, according to the WSJ.

Also, according to the WSJ article, CFC was a “big promoter of pay-option…ARMs. These give borrowers several choices each month, including paying no principal and less than the full amount of interest normally due. If they take that route, their loan balances grow, setting them up for much higher payments later on. CFC’s banking arm holds $27.8 billion of option ARMs on its books. Payments were 30 days or more overdue on 5.7% of these loans as of June 30, compared with 1.6% a year earlier.”

Earlier this afternoon, Lehman Brothers announced they were shutting down their subprime mortgage unit BNC Mortgage Corp., saying that credit market conditions prompted it to slash its subprime resources and capacity. Earlier this week, COF (Capital One) said it was closing its GreenPoint mortgage operation, as mentioned here yesterday. Now, tonight, B of A is bolding going where no man has gone before…wait a minute, the quote is to boldly split infinitives, remember—to boldly go where no man has gone before. There that feels better.

We have centered this blog on the collapse of the housing market including the silly mortgages that were invented to get as many people into homes. Tonight, we can only say that B of A is going to have its hands full with CFC. This problem cannot be fixed with $2 billion from B of A. The problem is that people cannot afford to continue on the path of borrowing money to continue their lifestyles.

The credit expansion period is OVER and now we will have contraction. This will be a very painful process for everyone. We hope you have taken precautions to reduce your debt. This new round of “reflation” will not work like the bubbles that were created in the past decade. This will be the Fed pushing on a string because the borrowing will not keep the markets from going down.