The Countrywide Bailout and the Macroeconomic Picture

As I mentioned a few days ago, Bank of America (BofA) is buying out troubled Countrywide Financial (a home mortgage lender) for more than $4 Billion, and taxpayers are going to help them finance the buyout. This is good news for Countrywide (whose CEO is being given a ludicrous $110 million going away present), but bad news for the economy as a whole, and for taxpayers.

I should mention that it has been rumored that BofA felt obliged to acquire Countrywide, because the two firms had some large derivatives contracts, and if Countrywide had folded, BofA would have to write-off some very large dollar figures–perhaps enough to wipe out BofA. But by buying out Countrywide, BofA now holds both sides of the derivative transaction (they are in effect both party and counter party) so they can just zero out those derivative contracts. I expect that regardless of whether or not they are able to offset their derivatives exposure, buying out Countrywide may still be disastrous for BofA. One of the longest standing legal precepts in mergers and acquisitions is: “When you buy a company, you also buy its liabilities.” The full downside risk at Countrywide is enormous. If the default rate spikes in the nascent recession, Countrywide’s mountain of bad paper could very well take BofA down with it. I think that A.P. Giannini (the founder of the Bank of Italy, which later became the Bank of America), is probably rolling in his grave right now.

What does the Countrywide experience portend for the larger economy? I believe that the credit collapse will eventually spawn numerous taxpayer-funded bailouts of financial institutions, some of them measuring in the hundreds of billions of dollars. In essence, the credit collapse is just getting started. The bad news that is presently being trumpeted about subprime mortgages, will soon apply to the entire mortgage credit market. There are so many institutions–banks, hedge funds, mutual funds with financial stock holdings, and more–that have direct or indirect subprime exposure, that once the dominos start to tumble there will be many billions if not trillions wiped out. So much debt has been re-packaged in so many different ways that nobody can tell who owns what debts, and exactly what property is backing those debts. (There are now a dizzying array of Collateralized Debt Obligations (CDOs), Convertible Contingent Debt Securities (CODEs), Enhanced Equity-Linked Debt Securities (ELKs), Mandatorily Exchangeable Debt Securities (MEDs), Stock Return Income Debt Securities (STRIDEs), Structured Investment Vehicle (SIVs), and even “Super SIVs”–SIVs that aggregate other SIVs.)

It is the bankers’ inability to assign risk that inspired the summer of Aught Seven credit collapse. Liquidity has dried up worldwide because bankers are terrified of issuing loans if they cannot evaluate risk. With all of the repackaging within repackaging, it is nigh on impossible to identify risk. The term “marked to market” has become meaningless. With so much debt marked to mystery (my term), we are in uncharted waters. In my estimation, anyone that isn’t apprehensive about the economy is a Pollyanna.

While much of the credit market is going through a meltdown, the credit rating agencies like Fitch, Moody’s, and Standard & Poor’s are of no help because it has now been revealed some of them were in on the sub-prime scam–artificially boosting credit ratings in exchange for bribes. (You can look for this scandal to be one of the biggest financial news stories of 2008, potentially much bigger than the Enron scandal ever was.). Any further turmoil in the financial markets–and I expect that there will be plenty–will surely depress stock prices and the value of the US dollar. The dollar is already in deep, deep Schumer. There is a significant chance of a full scale collapse of the US Dollar in 2008.

Knowing the way that things work in Washington, DC, I conclude that bailing out the bankers will eventually mean both higher marginal tax rates, and a higher capital gains rate. As previously mentioned, this is just one more reason to shelter most of your assets in tangibles. For the most part, tangibles are not taxed until after you sell them and realize a profit. And, as I also recently mentioned, here in the US, land and houses are not taxed by the Federal government(at least not yet.) I don’t expect the mortgage tax deduction to go away anytime soon, but I would not be surprised if once they feel the squeeze, the Federal government ups the size and number of unfunded mandates on cities, counties, and states, forcing them to increase property taxes.