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Bank of America Buys Struggling Mortgage Lender

January 11, 2008 at 6:05 PM EDT
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Bank of America plans to acquire Countrywide Financial, the nation's largest home loan lender, as part of a "rescue deal" intended to help ease the impact of the subprime mortgage crisis. BusinessWeek senior writer Roben Farzad explains the ins and outs of the deal.

JIM LEHRER: Bank of America to the rescue. Jeffrey Brown has our big mortgage story.

JEFFREY BROWN: Not that long ago, Countrywide Financial was a symbol of the real estate boom.

Last year, the nation’s largest mortgage lender originated nearly one in every six home loans, more than $400 billion in mortgages. It also serviced more than $1 trillion in other mortgage loans.

But in recent months, Countrywide became a different kind of symbol: of risky lending practices, foreclosures and defaults, and the so-called subprime crisis.

The company’s value plummeted, bankruptcy rumors swirled, even in the last few days.

Today’s rescue deal involves the nation’s largest consumer bank, Bank of America. It now becomes the nation’s largest mortgage lender, as well.

Roben Farzad has been covering the story as a senior writer for BusinessWeek magazine. He joins us now.

Roben, first remind us how Countrywide became so important in the boom.

ROBEN FARZAD, Editor, BusinessWeek: Countrywide really jumped at the chance to become the foremost mortgage lender. Much of this boom started around the 9/11 period, 2001, 2002, when we record low interest rates for the next two, three, or four years, and people who were still heartbroken from their losses in the stock market really started espousing this new reality that your home was the ultimate redoubt.

Everybody suddenly had this flare for the American dream. And Countrywide was all too happy to take advantage of that cheap credit and give loans to even the riskiest of borrowers. And the assumption being, as long as home prices go up, everybody is going to be OK.

JEFFREY BROWN: And then things changed. I mean, is it clear what caused its downfall at this point?

ROBEN FARZAD: Hubris. You know, if you are out there dispensing the notion that the housing market can defy gravity ad infinitum, you’re obviously going to embolden your mortgage brokers to go out and sell these loans.

We thought there was a new paradigm. Mortgage lenders like Countrywide thought that they could make the loans, one, because housing prices were going up at a record clip, and, two, they could repackage and sell them to Wall Street and institutional investors and keep the virtuous cycle of making loans, making loans.

And truth be told, as long as home prices went up, it didn’t matter if you only made $90,000 a year and took out a $500,000 mortgage. But that came to a crashing end in the past year.

Bank of America making a gamble

JEFFREY BROWN: So what bet is Bank of America making then? I mean, why buy it if it is so troubled and this subprime crisis continues?

ROBEN FARZAD: There is a bifurcated interpretation. I guess the cynics today, talking to people on trading desks, you notice the market was down quite a bit today. It's not like the market took this as much of a vote of confidence.

JEFFREY BROWN: I think everyone noticed that, yes.

ROBEN FARZAD: Bank of America last year made a $2 billion investment in Countrywide in the summer, thinking that it was getting a fire sale price at about $20 a share.

The market has significantly worsened since. Countrywide fell to about $5 a share. And it was almost a face-saving effort for Bank of America to go in and buy it before it fell to zero. That's the cynical, skeptical interpretation.

Point number two is Ken Lewis, the CEO of the really acquisitive Bank of America, is thinking this is a once-in-a-lifetime opportunity for him to catapult from being the number-five mortgage lender to number one.

You have this wounded player suddenly on the market. And in one fell swoop, they can go and make this boltan acquisition (ph) for just $4 billion. And the big thing that they can bring to the equation is Bank of America's cheap source of financing.

If you have a checking account at Bank of America or a money market account earning one or two points, that jibes beautifully with Countrywide's problems right now. They've been cut off from the credit market, so the hope is that the housing market comes back soon and makes him look like a hero.

JEFFREY BROWN: Now, it's being characterized as a rescue. Does it have any impact for borrowers, those distressed borrowers that are out there? Presumably their loans are still sitting there, right?

ROBEN FARZAD: You know, these loans, these borrowers would still be on the hook for these loans even through a bankruptcy proceeding, but I think this is more a rescue for the broader financial system.

When you have something like Countrywide, which, again, originated $41 billion in subprime mortgages last year, if that thing were to fail, that would send really painful ripples across the entire financial system.

You're talking about a system of confidence where it has hundreds of counterparties on Wall Street, other commercial banks, other mortgage companies. We very rarely see the outright failure of a financial services institution like that.

It brings to mind some of the banking crises we saw in the S&L crisis, in the Continental Illinois failure of 1982. There is an element of too big to fail. And so, more so than the opportunism, I think Bank of America was looking out for its own interests, in, "We need to rescue this cousin, lest we all suffer the consequences."

Shareholders upset

JEFFREY BROWN: There are some legal issues outstanding for Countrywide, and presumably Bank of America now takes them on. There's an SEC investigation. There are some shareholders suits. Tell us about that, where things stand in terms of legal liability now.

ROBEN FARZAD: Well, Countrywide CEO Angelo Mozilo, who really comes from unlikely roots -- he was the son of an Italian immigrant, a butcher of modest means -- and he very much was pushing this idea of the American dream.

He is painting himself as a victim, that regulators, and hucksters out there, and rogue mortgage brokers made him the victim, when in reality this company took daredevil risk.

And in fairness, I mean, actually, it's not very fair. He took out nearly -- when all's said and done, he will have paid himself $500 million. There's an exit package. He had an outsized pay package.

I mean, certain Wall Street executives with firms multiple times the size of Countrywide were making significantly less than him. So was he really a victim?

Shareholders naturally are livid that Countrywide paid its CEO as much. They're accusing the firm of pushing these risky loans on people, telling them it would all be OK. And Bank of America inherits all of this, the dog with the fleas.

But I think Ken Lewis is betting that that's all baked into the $4 billion stock price. For perspective, Bank of America is worth $175 billion. In the end, you know, hopefully they're not buying something like an asbestos liability and there will be an end to this crisis.

Hope of cushioning the impact

JEFFREY BROWN: And as you know, Countrywide a few months ago announced that it was going to take some steps to help at least some of the distressed borrowers to put the loans out further. How far has that effort gone at this point? And has Bank of America said anything in terms of helping any of those distressed borrowers?

ROBEN FARZAD: Well, there's an element of self-preservation, and that obviously it's in no one's interests to see these homeowners send back the keys in a FedEx envelope. You end up getting pennies on the dollar.

There already is a glut in the housing market, with new homes, existing homes. You don't want to add foreclosed homes, a whole spate of those onto the market.

And on top of that, we're in an election season. You saw what the candidates were saying about this recession. It's very much a subprime recession. And you want to look like you are throwing a bone out there.

Again, it's Angelo Mozilo talking about maintaining the American dream. I think it staves off the inevitable, because ultimately the brokerage, the brokers, the mortgage brokers like Countrywide, and the homeowners were banking on a constantly increasing home price.

Home prices have fallen this year. They're going to continue to fall. There's still a significant excess to burn down.

So Bank of America is making a huge bet here. But in the end, they're building in a margin of error. If it doesn't end up costing them $4 billion, maybe it will cost them $5 billion, $6 billion, $7 billion. You still have a mortgage portfolio of nearly $500 billion on Countrywide's books.

JEFFREY BROWN: All right, Roben Farzad of BusinessWeek, thanks again.

ROBEN FARZAD: Thanks, Jeff.