Follow the Money

The big news today is the purchase by Bank of America (BAC) of $2 billion in preferred stock in the beleaguered Countrywide Financial (CFC). Deals like this are not made overnight, which leads us to think it has probably been in the works for at least a couple of weeks.

Now it so happens that other unusual things have taken place in the markets during this time - some publicly known, others not. Follow the sequence of events and an interesting conclusion emerges.

8/15 - Merrill Lynch analyst says CFC is in danger of bankruptcy.
8/16 - Countrywide taps all its available credit lines, total $11.5 billion.
8/16 - Fitch and Moody's cut Countrywide credit ratings.
8/17 - Bank of America Securities analysts (who once worked at Countrywide) upgrades CFC.
8/17 - The Federal Reserve cuts the Discount Rate and eases collateral requirements.
8/17 - Morgan Stanley downgrades CFC.
8/20 - Countrywide begins staff layoffs.
8/20 - KBW downgrades CFC.
8/21 - Rumors abound that Warren Buffet is looking at a Countrywide acquisition.
8/22 - Four mega-banks borrow $500 million each from the Fed's discount window.
8/22 - One of the four, JP Morgan (JPM), upgrades CFC.
8/22 - Another of the four, Bank of America (BAC), buys $2 billion in preferred stock from CFC.

A number of curious things are going on here. First, while CFC's very survival was in doubt the BAC analyst still found reason to upgrade it.

Second, the four large banks borrowed from the Fed's Discount Window at a rate of 5.75%, even though they are perfectly capable of financing their normal cash needs at the 5.25% Fed Funds rate. Why pay a premium? It was explained that they wished to show confidence in the Fed and demonstrate that smaller banks need not fear that use of the Discount Window would be perceived as a sign of weakness.

This explanation does not pass the laugh test. These banks are publicly traded companies. They owe their shareholders a duty to obtain the best possible financing terms. Paying an extra 50 basis points when they don't need to, and then announcing it publicly, is financial malpractice and an invitation for shareholder lawsuits. The executives know this so they must have had other reasons.

This brings us to the third curiosity: soon after the banks borrow a total of $2 billion from the Fed (remember that number, by the way; you will soon see it again), an analyst for JP Morgan upgraded CFC. Two and only two analysts on the Street upgraded CFC in the last week. Both happen to be attached to banks that borrowed from the Fed on unusual terms.

Fourth and finally, Bank of America buys $2 billion in CFC preferred stock. Wall Street breathes a sign of relief that the crisis has passed. No one seems to notice that CFC's windfall happens to be the exact same amount of money that the Fed just loaned to a consortium of megabanks.

Conclusion: the Fed has bailed out Countrywide, using BAC and the other three megabanks as a conduit. The other $1.5 billion will find its way, via circuitous routes, from the other three banks into the BAC vaults. BAC is taking no risk in this deal because they are playing with the Fed's money.

Even before the Fed acted last week, the wheels were already in motion for this deal to come together. Either that, or this is all a series of really remarkable coincidences.

If in fact the Fed is trying to bail out Countrywide, there's a good chance it will take more than $2 billion. We may see more such exotic financing in the near future, or possibly they are also acting in other ways that are not yet apparent. In any case, having tried to do this the Fed cannot afford to fail. It would be a fatal blow to Bernanke's credibility. The stakes are huge.