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How Big Will the Bank Bailout Get?

Judging by Monday's gains in shares of most big banks, investors must have missed a certain New York Times article over the weekend.

The piece cited a confidential Bank of America (NYSE: BAC  ) bailout proposal the bank presented to members of Congress. In its plea for help from the federal government, the Times reported, the document "warns that up to $739 billion in mortgages are at 'moderate to high risk' of defaulting over the next five years and that millions of families could lose their homes."

$739 billion? With a "b"? Numbers this huge demand a moment to pause for reflection. Total losses to date from this crisis throughout the global finance sector amount to $200 billion. Apparently, Bank of America not only foresees that total rising by 370%, but also warns that the trouble may drag on for half a decade. The sum is nearly five times the $150 billion total of the fiscal stimulus package that Congress approved earlier this month, representing nearly 5% of U.S. GDP.

What does this mean for Bank of America?
If Bank of America has adopted forecasts that quantify the potential cumulative industrywide losses from the mortgage crisis, has the bank conveyed its projected portion of those losses to shareholders within the company's recent earnings report?  

Bank of America's 2007 annual report revealed $8.18 billion in remaining exposure to mortgage-related CDOs after writedowns, which sounded like a lot until this news. Although B of A did report an eyebrow-raising $104 billion in "special purpose entities liquidity exposure," it's clear that the market didn't think the company would actually lose that much. With Bank of America now becoming the largest mortgage lender, the company's share of a $739 billion loss would be substantial indeed.

How does it affect the Countrywide merger?
This revelation raises questions about Bank of America's acquisition of Countrywide Financial (NYSE: CFC  ) , announced last month. After initially reading the move as CEO Ken Lewis' giant gamble that the U.S. slowdown would be less severe and shorter than many anticipated, I now wonder whether it was an entirely different sort of bet.

The Federal Reserve and the Bush Administration have drawn their lines in the sand with respect to the U.S. markets, indicating that they will consider any measures to stave off massive equity losses. Within this context, they can ill afford to let any of the enormous banks go under.

Was the Countrywide merger a strategic gamble that the resulting size of the company would exert even greater pressure on those in power to guarantee the company's survival? What did Ken Lewis know, and when did he know it? These are all questions that shareholders will undoubtedly be asking as these losses unfold.

With the merger priced at an 80% discount to Countrywide's 52-week highs above $40, though, it is entirely plausible that Bank of America perceived long-term value at $8 per share. At least one Countrywide stakeholder agrees.

Will Bank of America be the only victim?
Hardly. Major mortgage-lending competitors Wells Fargo (NYSE: WFC  ) , JPMorgan Chase (NYSE: JPM  ) , Washington Mutual (NYSE: WM  ) , and Citigroup (NYSE: C  ) will presumably face their share of losses as well. Across the pond, too, European banks with significant exposures to mortgage-backed securities, such as UBS (NYSE: UBS  ) and Deutsche Bank, are sure to join the fray. The results for European markets and the euro itself could be similarly painful.

What's the bottom line for investors and consumers?
If the losses spur the type of bailout for which Bank of America is lobbying, consumers will foot the bill through tax increases and/or inflation. If the government leaves the markets alone, a reversal from recent actions, we'll face plummeting equity markets and a continued credit crunch, matched with severe home devaluation and overall stagflation.

In either case, investors can expect further spillover from mortgage defaults into losses on credit card debt, auto and student loans, commercial real estate, etc. Somehow, I suspect that even this $739 billion number will not be the banks' final answer.

For me, the light at the end of the tunnel was extinguished this weekend. For anyone who owns a major mortgage lender, this is your last call to run, not walk, to the nearest exit.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 28, 2008, at 2:08 PM, waukgal wrote:

    How many billions of dollars in CEO bonuses have these banks been giving out? I want every cent returned before even going to the table to discuss helping these banks.

    I am a taxpayer, and I was not given a high-risk loan. I waited seven years to be able to purchase a home. I do not now want to pay for all the people that were not ready. While I realize that something must be done, ALL bonuses should be returned, first. Clearly they are not deserved, and under these circumstances would be stolen from the American people. No politician who misses this point will get my vote.

  • Report this Comment On February 12, 2009, at 12:53 AM, DLW069 wrote:

    Where else can someone collect a HUGE bonus and continue working after having obviously performed so poorly? I guess no where but here! It doesn't take a rocket scientist to figure out that throwing money at this problem isn't going to work, the dollar is weak but soon will be crashing to a new low. I completely agree with waukgal for them returning the bonus although I would take it further by asking for the past years salary with it. Talk about poor performance! I keep hearing and reading that they have to pay TOP bonus etc to keep the top talent, excuse me?? This is the TOP talent?? YIKES! I was thinking a few new graduates with innovative ideas might be just what we need.. guess it couldnt hurt anymore than this did!

  • Report this Comment On July 19, 2009, at 11:49 AM, XMFSinchiruna wrote:

    For the record: Bank of America shares closed at $39.36 on the date of this publication. Seven months later, the $700 billion TARP program passed through Congress. Shares traded as low as $2.53 by the Spring of 2009.

  • Report this Comment On June 10, 2011, at 8:54 PM, Vreeland7 wrote:

    President Obama bailed out the banks.

    However, the banks went on to take homes from people in record numbers of foreclosures.

    A large number of those homes are still on the market and empty.

    Many are showing the affects of nonuse.

    The worst thing for a house is to be empty.

    All kinds of things can happen to it from vandalism to natural damage.

    In time, the property will have less value.

    Instead of working with those who are having financial problems due to the economy, the banks just take.

    The banks have been bailed out.

    They were helped with incredible amounts of money.

    Yet they will not help the people.

    They would rather have a house sit there and rot away instead of letting people stay in them to avoid being homeless.

    Where is Obama when it comes to people with little or no money?

    He will help the rich, but not the poor.

    Investment firms are buying houses at well below their values for future sales, thus making big profits.

    The firms visit a house and look for any and everything that needs fixing or an upgrade.

    Even if something is in great shape, they will say it is out of date and needs to be replaced.

    In the end, they get the house cheap.

    Why is this allowed?

    The rich get richer while the poor get, well, you know.

    Greed ruined the economy in the first place.

    Now it is ruining lives.

    The future looks scary right now.

    The people are accepting what is going on instead of rising up.

    We are being taken.

    Our own tax dollars are even being used against us.

    It is time to wake up or forever be a slave of a system that is not on your side.

    George Vreeland Hill

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