What Would Have Been Good for B of A Would Have Been Good for the US of A

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His predecessor made mistakes. But the new guy has run the place long enough to have made a difference. Yet people are frustrated after months of stagnation -- and his last-ditch speech didn't help.

President Barack Obama? Sure. But the description also applies to Bank of America (NYS: BAC) CEO Brian Moynihan.

As both B of A and the country continue to flail, the parallels are instructive.

What would have been good for Bank of America over the past three years would have been good for America, too.

Four days after Obama gave his speech to Congress in September, Moynihan stood before investors with his own slideshow version.

Moynihan's speech can be paraphrased as follows: Please, please, please don't think of mortgages. Of B of A's six divisions, Moynihan kept saying, five of them are making money.

Yet investors focus on the $838 billion in mortgages for which the bank still has exposure via the "representations and warranties" it made before 2008.

To address this "legacy mortgage crisis which started late in '06," as Moynihan calls it, B of A has shelled out $12 billion and socked way $18 billion in reserves.

Investors, though, worry that these mortgages -- and government investigations into how B of A has dispatched some of them -- will continue to consume capital and time, sucking growth from the rest of the bank.

B of A is slashing its jobs and shuffling key remaining people around. But "the mortgage business continues to hold the company's progress back," Moynihan admitted.

That's the case for the nation, too. Between 2000 and 2007, American mortgage balances doubled, from $4.8 trillion to $10.5 trillion. Since then, the figure has fallen. But it's down to only $10 trillion.

Obama can wax poetic about building schools and hiring teachers all he likes. But these distractions won't vanquish the debt that is smothering the growth we need to pay for these things.

Even if "only" $2 trillion of that extra mortgage debt was wasted money, it would cost Americans at least $125 billion a year, every year, for 30 years, to pay it off. That's heavy de-stimulus working against the borrowed cash that Obama wants to keep injecting into the economy.

How did B of A get all those mortgages, anyway? This story has a lesson for the American economy, too, as well as America's response to the financial crisis.

Much of the bank's "legacy" comes from its purchase of Countrywide Financial in 2008. When B of A bought Countrywide, it knew that the California-based mortgage lender faced losses from the bubble.

Yet Bank of America thought those liabilities were contained and controllable. It miscalculated. Rather than bringing Countrywide up, B of A is dragged down by Countrywide's dead weight.

In retrospect, it would have been better for B of A to wait for Countrywide to go bankrupt. Countrywide's bondholders and uninsured lenders would have taken their warranted losses.

With these creditors absorbing the hit, B of A would have had freedom to buy the good parts of Countrywide. B of A would have had cash left over, too, to reduce the debt that Countrywide's mortgage borrowers owed, putting a cap on future losses.

Perhaps most important, B of A would have avoided an incalculable hit to its reputation.

This situation is what bankruptcy is for. Bankruptcy segregates future losses and parcels them off to the people and institutions who signed up to bear those losses. The uncertainty surrounding those losses can't harm good businesses' growth.

Just as B of A took on liabilities that it could have avoided, America did the same. Beginning with its rescue of Bear Stearns' creditors in March 2008 and culminating in the Troubled Asset Relief Program and other rescues that began seven months later, America has taken on burdens that should have stayed within the financial system.

By guaranteeing bondholders and uninsured lenders at firms -- not just B of A, but AIG (NYS: AIG) and others, too -- America curtailed Americans' flexibility to reduce their mortgage balances.

Financial-industry bankruptcies would have forced private lenders to take their losses, allowing private borrowers to reduce their debt. Both sides of the ledger would have balanced -- and losses would have remained within the private sector (although the government still would have had to provide liquidity backstops in the panic).

Taxpayers may think that their TARP "investments" have turned a profit. But those "profits" sowed economic malaise by locking borrowers into unaffordable debt.

We all pay -- even the rescued. B of A has benefited from the Federal Reserve's 0% interest rates, which allow lots of people to pretend to be solvent and keep paying their debt.

But, as Moynihan said, low interest rates are "not favorable to banking." The Fed's new "Twist" -- forcing long-term interest rates down -- will further torture large banks' profits.

Just as unfavorable is "the unprecedented time of low growth in this country, and it's been going on for quite a while," Moynihan noted.

Long term, too, just as B of A could never jump in and save Countrywide today, weak countries can't bail out weak banks.

Moody's downgraded B of A in mid-September because the ratings agency thinks the bank is less likely to get a bailout, if necessary, in a future crisis. The stock price is around $6.20, little more than half what it was at the beginning of the quarter.

Even at this late date, Moynihan could try to throw Countrywide into bankruptcy, as he intimated at his presentation. If it's not too late for such a move, private creditors would take their losses, and B of A would move forward. Imagine that.

At the time this article was published Guest contributor Nicole Gelinas, a Chartered Financial Analyst (CFA) charterholder, is a contributing editor to the Manhattan Institute's City Journal. Nicole doesn't own shares of any companies mentioned. The Motley Fool owns shares of American International Group and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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