January 11, 2008

QuickLinks: SocketSite’s Countdown To Countrywide’s Sale Today

JustQuotes: Is The Subprime Sickness Spreading? [SocketSite 7/07]
Quicklinks: Countrywide “Materially Tightens" Underwriting Standards [SocketSite 8/07]
From Rumor To Reality: Up To 12,000 Layoffs At Countrywide [SocketSite 9/07]
Countrywide Secures Another $12 Billion As Application Volume Falls [SocketSite 9/07]
What A Difference A Year Makes For Countrywide Financial Corp [SocketSite 10/07]
Bank of America to Acquire Countrywide for $4 Billion [Bloomberg Today]

First Published: January 11, 2008 9:43 AM

Comments from "Plugged In" Readers

It looks like CFC found a husband at the end of a very long Federal Reserve shotgun. After all, someone has to eat the upcoming FHLB losses on the collateralized garbage that CFC pawned to FHLB to keep themselves alive over these past few months (tough to tell how much, but it's in the range of $80 BILLION). Ain't going to be the system, that's for sure. The Fed is a private bank, indeed. Now, how to sucker the taxpayer to bail out BofA in about a year? You can be sure they're working on that one right now....

Posted by: Satchel at January 11, 2008 12:51 PM

Yes, it sure seems like the Fed was instrumental in getting this deal put together and has offered some sort of financial backstop in order to avoid a failure that would really panic the markets. It will be interesting to learn the details.

Posted by: Trip at January 11, 2008 12:58 PM


I can (almost) guarantee you that the Fed isn't going to provide any backstop capital. The Fed is a private bank, and it is not in the habit of givings its dollars away for free. That is for the foolish taxpayer.

The Fed surely winked and nodded at BAC that it can continue to pledge all the garbage at the TAF facility (the Fed's new "anonymous" loan window) and - with a little collusive fraud from the accountants and lawyers - BAC will be able to delay recognition of the losses (and the MASSIVE losses to come) until Congress can put in place a new agency that will eat all this garbage, passing it on to the taxpayer. In the meantime, banks will continue to be forced into these shotgun marriages (rumors now that JPM will be forceably wed with WAMU - check out the stock action).

This is all VERY similar to what happened in Japan in the early 90s, where zombie banks were allowed to gradually recognize losses from their foolish loans to zombie companies. I'm expecting basically the same thing in the US - at least nothing that has happened so far is inconsistent with that view.

Posted by: Satchel at January 11, 2008 1:11 PM

Sorry, Satchel -- I didn't mean the Fed, I meant the FDIC. Although latest reports have the regulators denying any involvement . . .

Posted by: Trip at January 11, 2008 2:51 PM

Citi may take a $24 billion writedown, Merrill could be $15 billion.

Countryide is no more, WaMu may be next. The new BofA/CFC company will do no subprime at all.

The list of financial houses screaming in pain goes on and on.

And people think they're going to get a jumbo-loan anytime soon for 6%? hahahahahah

Posted by: ex SF-er at January 12, 2008 3:19 AM

hey ex=sfer,
i'm curious as to why that makes you laugh. does this benefit you in some way?

Posted by: paco at January 12, 2008 7:45 PM

Oh yes, ex SF-er, please elaborate. What is so funny?

Posted by: movingback at January 12, 2008 9:02 PM


Either you get it...or you don't :)

I guess another perfectly logical response can be crying...at the insanity of it all :(

Posted by: Chuck at January 12, 2008 11:18 PM

sorry... Chuck has it right... I'm laughing in a CRYING sort of way.

The situation in the credit markets and financial space is dire. Countrywide is likely insolvent. Many people believe that this deal is happening because if it doesn't then a Countrywide bankruptcy could cause cascading cross defaults which could in theory take down much of the American financial system (systemic risk).

At one time (maybe 2 years ago) I was a simple housing bear but thought I could insulate myself from the pain that was to come.

Since that time, I've taken many defensive actions to prepare, but watched as most of those around me continued to make questionable economic decisions (e.g. people making $100k buying $750k homes), and worse yet they were spurred on by our economic and political leaders.
(Remeber it's barely more than a year ago that we were still hearing "there is no housing bubble". Even now people still keep calling this problem "contained" and "subprime" when it is neither).

so here I am 2 years later, knowing that I am going to get pounded to help bail out the actions of the irresponsible, the unethical, and the immoral.

I will personally see sky high taxes (since I'm "rich"), very low returns on my investments (since the Fed will drop rates to as low as possible again), higher inflation (look at what the dollar has done the last year!)

so no, I will not benefit much. (I will concede, that I did make a fair amount of money by sniffing which way the wind was blowing and investing based on that... but it will be peanuts compared to the higher inflation/taxes I'm going to see).

WHO do you think will pay when/if countrywide goes BK? WHO do you think will pay if a combined countrywide/BofA goes under? (google "continental illinois", which ironically enough was eventually bought by BofA after our tax dollars nationalized it and took all the losses)

when I wrote the above post, I had just gotten off the phone with a friend who was complaining that his mortgage was "so expensive". He qualified initially for a Jumbo at 6.25% but now that he's nearing closing he's getting rates more around 7.75%. So he said "well, I'll just get this for now, and they told me that I can refinance later this year when it should be more near 6% again"

IMO his statement that shows a true lack of understanding of the problem... so I just have to laugh- what else can you do?

Posted by: ex SF-er at January 13, 2008 8:51 AM

The situation reminds me of a story.

In a land far far away, this poor villager saw a blanket floating away in the river. He immediately jumped in to retrieve it. The blanket turned out to be a bear that was drowning and it got hold of the poor villager. At the river bank, all the other villagers were "laughing" watching the man trying to wrestle the blanket out. They said, "Hey, let go of the blanket. Come back out." The poor villager didn't want any one to think that he was stupid enough to mistake a bear for a blanket, and he said, "I am letting go of the blanket, but the blanket won't let go of me. "Upon hearing that, the villagers laughed.

Posted by: Chuck at January 13, 2008 9:51 AM

Yup, ex SF-er, the effect of the bubble popping will not be contained to decreasaing house prices. At the peak $500B a year in consumer spending was funded through HELOCs, cash-out refis and long term owners selling out. When this spending gets cut off a nasty recession is not only predictable it's inevitable. Then you get a positive feedback loop going where people walk away from their house because they've lost their job. Foreclosures get worse. Credit gets tightened and house prices fall even further.

Posted by: diemos at January 13, 2008 10:55 AM

And people think they're going to get a jumbo-loan anytime soon for 6%? hahahahahah

I just got a conforming loan for 5.5%. On top of that I'm getting a second. The blended rate on both is 6%. Granted, I have excellent credit and income, but money is cheap right now, and I'm guessing it'll be like that for a while.

Posted by: anon at January 13, 2008 11:23 AM

hey ex-sfer,

i'm kindof in the same camp in that i watched others making unsustainable decisions, have seen negative returns on savings and am now worried about inflation and the purchasing power of the dollar. BUT, i think your reasoning may be a bit muddled; if we get inflation, eventually interest rates will have to go up (to attract foreign buyers of our debt) which should increase the value of the reserves of prudent folk. if the fed crushes rates in response to the coming deflation then cash/liquidity will be king and people will sell things for pennies on the dollar, making the investment environment positive for those with dry powder. i worry about the bail out of the banks (and california, u.s govt. etc..) but i do not see anyone suggesting massive tax increases, b/c that will further curtail discretionary income and cause more deflationary pressures. anyway since you are "rich" you have been enjoying 15% cap gains rates which, we can probably agree, have been sweet. and as you noted you have been given a coupla years to be defensive by which i assume you mean that you are stockpiling reserves; therefore i should think that when TSHTF you will be well positioned to take advantage. although i am not looking forward to mass pain and suffering i am assuming that my forbearing lifestyle (small mortgage, small expenses, large reserves) will enable me to profit from such a scenario. in other words it sounds like we will benefit from having many choices while the formerly foolish will have few choices (and none of them good).

am i wrong??

Posted by: paco at January 13, 2008 1:42 PM

FWIW, paco, I don't think you are going to have to worry too much about inflation, although there will of course be selected price inflation in certain commodities and services. People who look to the 1970s stagflation as the likely outcome of what is going to happen either don't know much about the 1970s, or don't understand the current situation too well.

In very VERY broad and incomplete outline, the late 1960s through the early 1980s (ending with Volcker from about 1979) were characterized by tight fiscal policy (smallish deficits, high taxes) and loose monetary policies (monetization of deficits, and the untethering of the dollar from gold in 1971-73). The period of the early 1980s through the early to mid-2000s has been characterized by the opposite: tight monetary policies (no monetization, gradual growth of base money) and loose fiscal policies (large deficits in the 1980s especially, and significantly lower taxes from 1986 onwards).

We now face a deflating credit bubble. A very large one. Take a look at the chart:


The Fed will cut rates of course, but they will NOT print. At least not yet. If the lower rates do not ignite another asset bubble, we are looking at serious deflation, as all this debt is retired, defaulted or slowly paid down.

My best guess is that this all plays out similar to Japan. Remember that Japan ultimately "printed" something like 10-12% of GDP in the late 90s/early 2000s to no avail. When you reach something like 350% debt/GDP ratios, and credit begins to contract, no amount of monetary "printing" (short of Zimbabwe-style hyperinflation) can stop the destruction of money/credit. Keep in mind that the entire US monetary base is only about $860 billion, and the credit comples is > $40 trillion. You can see that even a 10% reduction of money/credit would require printing on the order of 30% of GDP to offset. And a lot more than $4 trillion is going to die and go to money heaven.

People who think that there will be widespread inflation cannot give you a cogent answer as to why the long bond is yielding only 4.3% and going lower, although they will try. BTW, these are the same sorts of arguments as to why the JGB (Japanese Government Bond) was supposed to increase in yield beyond 6-7% as the BOJ went to quanititative easing. It never happened (the yield increase, that is) because the bond market correctly anticipated aggregate deflation. JGB yield ultimately went below 2% (where they are right now, BTW), and I think they may have even spiked below 1% (for a 10Y bond!!) but I haven't checked the charts in a while.

Cash will be king, and gold (in its role as money) will also have a place in the upcoming debacle, IMO.

There is a slight chance of policy error/hyperinflation. IMO, this would only really happen if things get so bad that Congress takes back control of the monetary system, which is VERY unlikely. Even a depression is not such a bad thing if you are the government, or if you are the Fed. But a hyperinflation leads to change of government, and reordering of all the goodies that come with power. Very unlikely.

The only real hedge against hyperinflation IMO is foreign currency (preferably creditor countries like Japan and - to a lesser degree - Swiss Francs (not as good as it used to be)) and gold, in each case HELD OVERSEAS. Gold I guess could be buried in your backyard. If TSHTF, you can be CERTAIN that the US government will slap on capital controls, and will confiscate gold. So do not keep it in a safe deposit box. People who think this is loony (as I said, the risk of hyperinflation is very small), do not know their history, and would probably be surprised to learn that the US government did in fact confiscate gold in the past, and on a widespread basis.

Posted by: Satchel at January 13, 2008 7:07 PM

There seems to be a misperception that a 15% capital gains tax rate somehow means all (non-real estate) gains are taxed at 15%. That would be "sweet" were it so.

Sure, if you loaded up on AAPL in '96 or '02[*], bought your PYPL shares in 2000, or exercised your GOOG options prior to IPO[**], you're loving a 15% capital gains tax rate. Who was crazy enough to put 100% his money in post-Gil-Amelio AAPL? This is the exception, not the rule.

Take a look at your 1099s and see how your mutual funds split between income and capital gains. And if you've got money in absolute returns, "exotic/alternative beta," etc, I'd wager quite a bit of those returns are income hitting your marginal rate.

During the housing boom, it was a far better deal to flip your house every two years and buy a new primary residence.

BTW, this is not a complaint. Personally, I've always done better taking gains and worrying about taxes later. Just wanted to counter the notion that all non-housing money has seen a magical 15% tax rate.

[*] The fruit traded less then a dollar above cash-per-share in '02. Remember this in the next recession.

[**] Although a substantial amount of the GOOG pie, only a small number of individuals fell in this category. The majority of GOOG money blamed (accurately or otherwise) for distorting housing undoubtedly was taxed as ordinary income. Take heart at the thought of twenty-something progressives filing quarterly.

Posted by: exuberant at January 13, 2008 9:30 PM

hey satch,

i've been watching the same movie over on CR and Mish and following the action closely so i've heard the arguments and i'm in your camp re: deflation. but i'm no gold bug. in reality i think that, like yourself, most of the people i know are fiscally responsible and live quite within their means. i know that to be true of my parent's circle as well. so i'm having a hard time seeing how a depression is going to hurt. if the world is crashing i would think that the overextended will get hurt, people will lose their jobs and desperation will be on the rise. that will mean that the rich will close ranks and use their power and resources to protect what they have. and i would think that means paying for security but also having the ability to hire it cheaply. if so many are poor then the ones who are not will be in the position to secure assets for pennies on the dollar.

i understand the logic of cascading defaults but i don't see people starting to starve overnight. i don't see u.s.t-bills defaulting. ( if they did, would there be enough of a monetary system left intact to make gold or swiss francs viable?) in other words, do you believe that a great depression would actually destroy the gap between the have's and the have-nots?
i have yet to see anyone explain how that would happen.
and i'm not buying the de-coupling theory that keeps the rest of the world's rich in clover while our rich go begging. what am i missing?

Posted by: paco at January 13, 2008 9:34 PM


No, you're not missing anything. What you are saying is very sensible, and like I said, the risk of a hyperinflation is VERY small - not because people have lived within their means (in aggregate, I disagree a bit - the US has lived WELL BEYOND its means; the buildup of debt, and the very worrying trend in the current account show us that) - so your idea that people with dry powder will be able to buy for pennies on the dollar is almost certainly right. But it might take a while, because the government will seek to moderate declines wherever possible, in order to "trap" as many people in depreciating assets (better that they take the loss than the banking system).

I'm not a huge gold bug either, but it does have its place. Even in the Great Depression, the price of gold increased (in dollar terms) by 55%, although it had a little "official" help there after the passage of the Gold Reserve Act.

The main reason that the risk of a hyperinflationary depression is unlikely is that we will have understanding creditors (Japan and China, certain Middle East autocracies, mainly) who for various reasons will help the US work its way through the coming credit deflation. Also, having thousands of nuclear weapons (and the means to reliably deliver them anywhere) is a great inducement to a "workout"!

Posted by: Satchel at January 14, 2008 5:40 AM

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