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Generational Dynamics Web Log for 13-Jan-08
Throwing good money after bad: Bank of America will acquire Countrywide Financial

Web Log - January, 2008

Throwing good money after bad: Bank of America will acquire Countrywide Financial

And Saudi Arabia and China plan to invest in Citibank, as writedowns increase.

Last August, hundreds of anxious investors panicked and mobbed the banks owned by Countrywide Financial Corp., demanding to withdraw their deposits, for fear that Countrywide would go bankrupt. The fears arose after Countrywide had drawn down its $11.5 billion credit lines, for fear that those credit lines would become unavailable.

A week later, Bank of America invested $2 billion in Countrywide in return for 16% ownership of the company.

Countrywide's problems in August were attributed to the worldwide "credit crunch" that occurred at that time. The credit crunch has eased considerably since then, thanks to massive amounts of liquidity being poured into the financial system by the Fed, the Bank of England, the European Central Bank, and other central banks.

But Countrywide's problems haven't abated. And no surprise -- Countrywide has been the leader in encouraging abusive use of credit in the last five years, having approved millions of "liar loans" to people with no income, no assets, no honesty, and no chance of making the payments after the initial "teaser" rates expire.

Countrywide reported its first loss in 25 years in the third quarter. Early this week, Countrywide admitted that its foreclosures and late payments on its mortgages hit a record high in December. Foreclosures were at double the level of December 2006, and overdue loans were 50% higher. This announcement caused Countrywide's stock to plummet, meaning that Bank of America has already lost a substantial part of the $2 billion investment that it made in August.

What's the solution?

On Friday, Bank of America agreed to acquire Countrywide completely for another $4 billion.

Is this "throwing good money after bad"? I have little doubt that it is. The WSJ says that it's "a gamble that the U.S. housing crisis is near a bottom and that Countrywide's assets won't further deteriorate," two assumptions that are both bound to be wrong. On the other hand, $4 billion is a cheap price for a company that was worth over $20 billion just a year ago, so perhaps there's enough of a cushion in there to make the deal worthwhile over the (very) long haul.

Countrywide's assets are bound to deteriorate further because the assets of almost every major financial institution continue to deteriorate.

Take Citibank for example. They're going to announce their fourth quarter earnings on Tuesday, and they're expected to be sharply lower.

Recall that Citibank tried to save itself by means of a fraudulent scheme known as a "Master-Liquidity Enhancement Conduit (M-LEC)." Under the scheme, Citibank and other banks would sell worthless CDOs to each other at inflated prices, in order to establish a phony "market price" for the CDOs. Citibank's fraudulent M-LEC idea didn't take off, forcing the bank to take $16.4 billion in writeoffs of worthless CDOs after all. Citibank might have gone bankrupt except that it was saved by a $7.5 billion investment by the Abu Dhabi Investment Authority.

Well, now the expectation is that Citibank is going to have to take even more writeoffs -- perhaps as much as $19 billion more -- to be announced along with the earnings statement on Tuesday.

At the same time, it's been reported that Citibank (actually Citigroup) is looking for new investments totalling $14 billion. The investments are to come from Saudi Prince Alwaleed bin Talal and from the China Development Bank.

It upsets us to see Bank of America throwing good money after bad, but we don't feel so much pain when it's foreign investors throwing good money after bad.

If you look at the big picture of what's going on in the world, what we're seeing is a corporate version of the Principle of Maximum Ruin.

This is a principle that I've discussed several times on this web site with respect to individual investors. It means that people will keep investing in the stock market until they lose everything - the maximum number of people will be ruined to the maximum extent possible.

What we're seeing now is a corporate version of the same principle.

Recall that the amount of money in the world is decreasing every day. This is because investors and institutions are becoming more and more risk aversion with credit. It's credit that creates money, and it's the abusive use of credit that's created the liquidity bubble that we've been living in the past few years.

But it all turned around in August. At that time, there was a massive shift in the attitudes and behaviors of great masses of investors, and they became much more risk-averse. With the use of credit being reduced, the amount of liquidity in the world is being reduced.

When low tide pulls the water from the shore back into the lake or ocean, it leaves behind little pools of water called "tide pools." Those tide pools don't last long, since they're drained away by leaks in the sand beneath them, but they exist for a while, and they often trap a variety of sea creatures with them.

Well, as the liquidity of the world pulls back and disappears, it leaves behind these liquidity tide pools -- in corporate coffers, but also in places like Saudia Arabia, Abu Dhabi, Singapore or Beijing. But the liquidity tide pools soon leak away, just as the water tide pools do.

The sizes of these country liquidity tide pools are listed on the US Treasury web site. Here's a listing of the most current posting:

        Country               Amount (billions of dollars)
        --------------------- ----------------------------
        Japan                 591.8
        China, Mainland       388.1
        United Kingdom        296.5
        Oil Exporters         130.3
        Brazil                112.8
        Carib Bnkng Ctrs       78.1
        Luxembourg             70.1
        Hong Kong              54.2
        Taiwan                 53.4
        Germany                44.1
        Korea                  43.3
        Singapore              35.9
        Mexico                 33.2
        Switzerland            31.7
        Turkey                 26.5
        Canada                 21.4
        Thailand               20.0
        Netherlands            19.5
        Sweden                 15.3
        Russia                 14.9
        France                 14.7
        India                  13.7
        Italy                  13.6
        Ireland                13.1
        Poland                 12.3
        Belgium                11.3
        Israel                 10.2
        All Other             139.5
        --------------------- ----------------------------
        Grand Total          2309.5

It seems like $2.3 trillion may seem like a lot of money, but remember that even mainstream analysts says that bank asset writedowns will cause a loss of $2 trillion in credit. When you consider that there are hundreds of trillions of dollars in credit derivatives in the world, $2.3 trillion is a drop in the bucket.

So these liquidity tide pools are not all that big in the grand scheme of things, and what we're going to see more and more is that these tide pools of liquidity will leak away, as the money is used to buy stakes in Citibank, or other investments -- in other words, by throwing good money after bad.

Thus, the Principle of Maximum Ruin will end up applying to Saudi princes and Chinese bankers as well as Main Street investors.

From the point of view of Generational Dynamics, there's a generational panic and crash coming, and it will be an equal opportunity financial destroyer. (13-Jan-08) Permanent Link
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Generational Dynamics Web Log for 13-Jan-08 Throwing good money after bad: Bank of America will acquire Countrywide Financial

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Generational Dynamics Web Log for 13-Jan-08
Throwing good money after bad: Bank of America will acquire Countrywide Financial