How the Worst Deal in the History of Finance Could Get Even Worse

Countrywide mortgage
Countrywide mortgage

"It's the worst deal in the history of finance." So said University of North Carolina banking and finance professor Tony Plath recently to The Wall Street Journal, in reference to Bank of America's (BAC) 2008 purchase of Countrywide Financial.

At the time, Bank of America thought the mortgage originator, priced at $2.5 billion, was a bargain, but not anymore. One estimate puts the bank's total cost of acquisition at more than $40 billion, and the fun may not be over yet.

What They Were Thinking

By late 2007, America's real estate market was obviously on the way down, but no one knew it was about to fall off a cliff, or that it would almost take the rest of the planet down with it when it did. According to the Journal, Bank of America's then-CEO Ken Lewis believed that the home-mortgage market was about to hit its low point and wanted to get in on the action while he still could.

Countrywide Financial was co-founded in 1969 by Angelo Mozilo, a take-no-prisoners entrepreneur who was also the company's CEO. By 1999, after 30 years of struggling to make a dent in the mortgage market, Countrywide had 7.3% of market share. By 2004, however, its share had jumped to 13.1%, making it the country's No. 1 mortgage originator.

Unfortunately for soon-to-be-owner Bank of America, much of that growth had been fueled by what turned out to be financial time bombs: subprime loans and adjustable-rate mortgages. Yet in 2007, Mozilo somehow managed to sell Bank of America a $2 billion position in Countrywide, and by July 2008 he had sold Bank of America the entire company.

Mozilo was convicted in 2010 of securities fraud and insider trading by the Securities and Exchange Commission. By the end of 2009, Lewis was gone from Bank of America, replaced by current CEO Brian Moynihan. At the time of the Countrywide purchase, Moynihan was Bank of America's investment banking chief.

We Broke It, You Bought It

"Obviously," Moynihan remarked in 2011, "there aren't many days when I get up and think positively about the Countrywide transaction." According to the Journal, Bank of America has spent most of the estimated $40 billion Countrywide cleanup cost on real-estate-related balance-sheet write-offs, funds set aside for toxic mortgage-backed securities claims, and legal costs relating to the Countrywide purchase.

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Bank of America now believes it has gotten a handle on the Countrywide issue, though it acknowledges it's holding out the possibility of another $5 billion in related losses. But is even that number to be believed?

Too Big to Understand

The superbanks, which also include JPMorgan Chase (JPM) and Citigroup (C), have balance sheets so vast and so complex, it's really anyone's guess as to whether the mountain of irresponsible lending in any of these institutions that led directly to the worst financial crisis in generations is even close to being cleared up.

JPMorgan had a $100 billion bet placed in the derivatives market that CEO Jamie Dimon didn't even know about until it started to go unmistakably south. He's still doing damage control on that one. Related losses were initially estimated to be $1 billion, but that quickly changed to $2 billion. Now, loss estimates range as high as $9 billion.

If Jamie Dimon, almost universally recognized as one of the best bank CEOs and risk managers in the business, can be so stupendously wrong when it comes to what's going on in his own bank, what about Brian Moynihan, then?

%Gallery-159044%Gillian Tett, who writes on the banking sector for the Financial Times, and who authored one of the defining books on the financial crisis, Fool's Gold, recently wrote a column addressing bank size and complexity in relation to the botched JPMorgan trade. But it also applies nicely to Bank of America's current situation: "If you want a reason to break up the banks, you do not need to worry just about 'too big to fail'; the real danger today is that financial institutions and markets are becoming 'too big to understand.'"

That's how the worst deal in the history of finance could get even worse.

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John Grgurich is a regular contributor to The Motley Fool, and holds no positions in any of the companies mentioned in this column. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Citigroup.