Thinking the unthinkable
Fine print – November 2011
At the risk of inadvertently echoing former Defense Secretary Donald Rumsfeld and his “known knowns” and “known unknowns,” let me postulate the following regarding the future of Bank of America Corp.: We know what we know,we know what we don’t know, and at some point we’ll think the unthinkable. The time has arrived for the latter.
Actually, I’ve already started. In recent weeks I’ve found myself returning to the idea that the Charlotte-based behemoth will not survive. The first couple of times that thought popped up, it felt like one of those outlandish theories you know is crazy, such as the one peddled by 9/11 truthers, but you get a cheap thrill by entertaining it a few moments. After a while, it stopped being crazy and started taking on the feel of something that falls somewhere between “unlikely” and “possible.” Nowadays, depending on the latest news and level of investor confidence, my mental meter swings between those two — but increasingly more toward “possible.”
Let’s start with what we know. BofA stock is, as of this writing, down 60% from its 2011 peak and 89% from late ’06, when its price hit a historic high. The bank is cutting staff, the government ordered it to limit its dividend to a token penny a share, and unhappy investors who bought its securities practically have to take a number at the courthouse to await their turn to sue. BofA has been selling assets to raise cash and is reportedly considering putting its Countrywide Financial Corp. subsidiary into bankruptcy to keep it from dragging the whole thing into the abyss. (That nugget came from The Charlotte Observer, which cited four unnamed people, obviously insiders. Apparently, I’m not the only one pondering worst-case possibilities.)
What we don’t know is how much damage the various lawsuits over mortgage-backed securities will wreak. BofA, judging by how much money it has set aside to settle claims, puts the number at $30 billion. But its potential liability is in the hundreds of billions of dollars, according to some estimates. In September, federal regulators sued 17 banks over mortgage-backed securities sold to Fannie Mae and Freddie Mac, and The New York Times estimated that BofA’s exposure in that case alone could be as high as $57 billion. To put that into context, BofA’s market valuation at the moment is $62 billion.
There are three ways for the bank to find its way out of this thicket. There’s a market solution, a legal solution and a political solution. The odds against any of them working are discouragingly high.
The market solution — the course BofA has embarked upon — is to cut costs, sell assets, maybe issue more stock to meet capital requirements, and generally grind along until the economy rights itself. There are formidable problems with this plan: The only assets anyone wants to buy generate cash for the bank, and this is not the moment for BofA to shed revenue-producing operations; issuing more stock dilutes an already beleaguered share price; and it’s hard to make a compelling case that the economy is going to bounce back anytime soon.
A legal solution, then? It’s possible BofA could make its problems go away with the $30 billion it has earmarked to settle the various claims against it. That will happen as soon as America’s commercial litigators simultaneously announce that their highest service to mankind is to stay out of the courtroom to ladle soup at the homeless shelter.
That leaves a political solution. In this scenario, BofA is helped by its size: Its failure would almost certainly reverse what small steps toward recovery the economy is making — and politicians know where the blame would fall. So there’s an incentive for them to orchestrate a sweeping settlement of all claims involving mortgage securities, a la the tobacco settlement of the ’90s, and engineer a way to undo the logjam of foreclosures.
But there’s political risk in that course, too. With the exception of a few casualties such as Lehman Bros. and Wachovia, Wall Street was left relatively unscathed by the mortgage meltdown it created, certainly in a legal sense (almost nobody’s gone to jail) and generally in a financial sense (BofA’s troubles are unique, fueled largely by its acquisition of Countrywide). Everyone has noticed this lack of consequence to an industry that, by the very act of initiating a foreclosure, insists that consequences must be paid when the mortgage isn’t. It’s not hard to imagine the Obama administration, which rarely hesitates to score political points at the expense of the wealthy, sacrificing BofA to the Occupy Wall Street mob and like-minded souls who believe the lords of finance got away with something.
And they did, though on balance BofA got away with less than others. Therein lies the irony: Our homegrown giant didn’t generate problems as much as it bought them. That’s a helluva thing to get the death penalty for.