BofA's Countrywide Gamble [WSJ]
Time Will Tell if Ken Lewis Has Made a Prescient Bet Or Prematurely Timed Flub
August 24, 2007; Page C12
Bank of America's shareholders are benefiting from a self-fulfilling prophecy. The very act of injecting $2 billion of fresh capital into Countrywide Financial shifted the market's perceptions about America's largest home lender on a dime. And with that, Bank of America's investment in convertible preferred securities surged into the money.
[Kenneth Lewis]
But perception isn't fact. If Countrywide's woes are primarily liquidity driven -- that is, they simply reflected the bank's inability to fund itself -- then Bank of America's investment will prove masterful. It will have paid not just below market price for the stake, but less than 80% of book value, or assets minus liabilities.
So glasses raised all around the bank's Charlotte, N.C., headquarters? Not so fast. The real test will be how well the loan book at the mortgage provider led by the preternaturally bronzed Angelo Mozilo holds up amid the continuing housing market shakeout. Countrywide holds nearly $30 billion of riskier mortgages known as option adjustable-rate mortgages and has seen defaults on these more than triple in the past year.
Sure, by paying below book value, Bank of America boss Ken Lewis has some protection against continuing credit problems. But if these substantially worsen, he may find himself looking a little like Warren Buffett did 20 years ago.
[BofA]
Hold on -- what is so bad about being compared with the Sage of Omaha? Well, even the Berkshire Hathaway boss can get his market timing terribly wrong. Indeed, think back to September 1987 when Berkshire Hathaway bought a block of Salomon Brothers convertible preferred stock -- the same stuff Bank of America just bought.
That deal, seen as savvy at the time, became a headache for Mr. Buffett. Stocks fell the next month and Salomon was embroiled in its Treasury trading scandal a few years later, forcing Mr. Buffett to take management control of the firm. BofA's shareholders better hope Mr. Lewis hasn't prematurely timed his foray into the mortgage mess.
No Pain, No Gain
Financial markets are breathing a sigh of relief. Central bankers' decisions to flood the markets with money on attractive terms -- the latest move being the European Central Bank's provision of €40 billion ($54 billion) -- seems to have averted panic.
But if the panic is over, it is too soon. The credit crunch probably hasn't caused enough pain. A few hedge funds and mortgage brokers have closed their doors and investment banks are going to have a crummy third quarter. Yet if bonuses this year fall 15% from last year's record, it would constitute only a minor haircut.
There could have been even less pain. Financiers have been lobbying the Fed to cut interest rates. Instead, by dealing with the panic with injections of money, the Fed and the ECB have resisted pressure to distort their interest rate policies. That will be good, if it holds. It might have been even better if less liquidity had been injected into the system -- or, at least, if those who borrowed from central banks had paid more of a penalty.
Why is pain a good thing? Well, because without pain, people repeat the errors of their ways. When Alan Greenspan ran the Fed, he was arguably too keen to soothe market jitters. So risk appetites rebounded rapidly after the Long-Term Capital crisis, fueling the technology-stock bubble. When that popped, risk appetites returned rapidly again, leading to the housing and credit bubbles.
If there is insufficient pain this time, the next bubble will be even bigger. So what if there is an even bigger bubble? Won't central banks ride to the rescue again? Maybe. At some point, the bubbles will get too big for even them to handle. What's more, this bubble has popped with the global economy in good shape. If the next one bursts when the economy is sick, there could be real damage. |
