I thought it was bad last year at this time. This jan its way worse. what will next jan hold?
Destroying Bank of America While Saving It Tuesday, Feb. 03, 2009
While the battle between Bank of America CEO Ken Lewis and former Merrill Lynch CEO John Thain goes on over who knew about large bonuses and large losses and when they knew it, recent news that the bank will get $20 billion from the federal government along with $108 billion in loss guarantees has almost been forgotten. Much of the paper being supported by the government came from the Merrill acquisition.
The other important issue which has been raised is whether Merrill Lynch hid any of the problems on its balance sheet from B of A. According to Reuters, "New York Attorney General Andrew Cuomo is reportedly looking into whether federal bailout loans to BofA were used appropriately, and if shareholders of both companies were given all the necessary information about Merrill's finances."
All of the battling between the heads of Merrill and B of A is bound to take the combined company's eye off the ball of fixing the big bank. Even the board is bound to get tied up in the drama. So far it has supported Lewis. There is no way to know how long that will go on and who might replace him if he is forced to step down.
The federal government's problem is that, if it does not want to see its capital put at more risk, it needs to encourage the resolution of the dispute. But, investigations take time. That means Lewis could be tied up in the imbroglio for months. There is no elegant solution to the problem.
For the time being, both Cuomo and federal authorities should pass the ball to the Bank of America (BAC) board. It has a duty to look into the Merrill merger and decide what should be done about any misconduct. It is not unusual for boards to hire outside counsel to look through complex matters involving potential executive malfeasance. During the options grant scandal two years ago, boards often took the lead getting to the bottom of these sorts of issues.
Having the several government authorities in the mix of parsing how the Merrill merger went down puts too many cooks in the kitchen. The B of A board was not paying attention to management when it invested in risky assets and lost billions of dollars. Perhaps its members can earn their fees now.
AIG is to date the most expensive corporate bailout in American history, requiring $180 billion of government funds. But it may soon have competition. Last week, mortgage giant Freddie Mac said that it had lost $50 billion in 2008 alone. A look at the company's books suggests the government will have to spend at least triple that much to save the financial firm from collapse. If the housing market worsens, the tab could even be larger.
"Freddie's portfolio of [mortgage] insurance is more risky than the market was led to believe," says Paul Miller, an analysts at FBR Capital Markets. Sister company Fannie Mae lost even more last year, with $58.7 billion of red ink. But Fannie was better capitalized than Freddie going into the credit crunch. So even though Freddie by many measures is smaller than Fannie, the problems at Freddie will probably end up costing more.
Citigroup and other banks have also lost money, and will need more capital to survive. But in those cases it's not clear who will take the hit - shareholders, bondholders or the government. In the case of AIG, Freddie Mac and Fannie Mae, however, there is no question where the money will come from. Freddie and Fannie were taken over by the government and put into conservatorship last fall. AIG is now 80% owned by the government. The losses at those companies are now taxpayer losses. (See 25 people to blame for the financial crisis.)
And like AIG, Freddie has had to come back to the government a number of times with cup in hand. The mortgage giant has already received $14 billion in government aid. After the fourth quarter loss of $24 billion, the company said it needs an additional $31 billion from the government to keep the lights on.
Freddie's business, which in part comes from a government mandate, is insuring mortgages. So when borrowers lose their jobs, as many now are, Freddie is going to lose money. But only a quarter of Freddie's red ink, or about $13 billion, comes from mortgage insurance woes. The firm took a larger hit from its investment in mortgage-backed securities tied to subprime, adjustable-rate or jumbo mortgages. By law, Freddie isn't allowed to insure against losses on those types of mortgages, in part because they are riskier. But it bought securities tied to those home loans anyway - which it is allowed to do - in order to capture the higher rates of return that those mortgage bonds offered. Unfortunately, the bets didn't pay off. Freddie lost $16 billion on those investments. (See pictures of Americans in their homes.)
Another bet that didn't pay off for Freddie was on interest rates. The firm's managers bought derivatives that would pay out if interest rates rose. Instead, a global financial meltdown has caused interest rates to plummet. That resulted is a $15 billion loss for Freddie from its hedges.
Freddie lost another $1 billion on bonds tied to short-term loans made to Lehman Brothers. Like Lehman, that investment went belly up. Then there are all the houses it now has to repossess as people stop paying their mortgages. The company now owns about 30,000 homes. Maintaining these houses cost about $3,300 a month each, and that comes on top of the loan loss, which is typically about one-third of the size of the mortgage. Wave goodbye to another billion.
When will the red ink at Freddie stop? It's hard to say. In its most recent annual report, the company said that if it had to mark all of its assets to the price similar bonds are trading for in the market, the company's net worth would sink by another $65 billion. But Freddie's bottom line woes may run deeper even than that. Freddie has $38 billion in losses it has yet to acknowledge in its investment portfolio. The firm also has additional $48 billion in non-performing loans that it either holds or has guaranteed against. In a painful stroke of irony, there is a $15.4 billion line item on the asset side of Freddie's balance sheet for deferred taxes. That means Freddie is still hoping to claim $15 billion in write-offs against future profits. But since Freddie continues to lose money, and because it is now part of the government, the likelihood that the company will have to pay taxes anytime soon is probably nil. Add all those items up, and it becomes apparent that the government will likely spend more than $100 billion in additional funds cleaning up the mess at Freddie.
"The losses at Freddie show the pressure the banking system as a whole is under," says Fred Cannon, chief equity strategist at Keefe, Bruyette & Woods. "Freddie is going to need more capital, but they are not alone."
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