Explaining Southern California's economy

Why Warren Buffett can't lose on Bank of America

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Bank of America customers use an ATM on January 21, 2011 in San Francisco, California. Bank of America reported today that it has reached an agreement for an $8.5 billion settlement with a group of investors who lost money buying mortgage-backed securities from Countrywide Financial.

Recall, if you will, this past summer when Warren Buffett put a floor under Bank of America's then-plummeting stock, serving up a $5 billion "Buffett bailout." Now, as one of the worst years for bank stock ever winds down, Bank of America has been headed South again. Yesterday, it dropped through the symbolically important $5 per share level (it's back up over $5 today). As the Wall Street Journal reports, Buffett is now like a lot of people who hold BofA mortgages: $1.5 billion underwater.

Is Buffett concerned? Probably not:

Don’t worry about Buffett, though. He is guaranteed a profit on his BofA investment. The banking giant must repay Buffett’s $5 billion, plus a 5% premium, at any time. Plus, the world’s third-richest man will rake in dividends of $300 million a year from BofA, and he won’t give up those payouts no matter what sub-basement BofA shares tumble into.

So why is BofA having so much trouble? There are basically two reasons. First, it's still suffering from its purchase of Countrywide, the subprime mortgage lender, prior to the financial crisis. Second, it's a whole new world for banking these days, as the New York Times explains:

Besides Europe’s financial problems and the overhang from hundreds of billions in bad mortgage debt, banks also face worries about new rules requiring them to set aside more capital that could lower future profits. “For financials, the higher capital requirements mean they have less money to make money with,” said Brad Sorensen, an analyst for the Schwab Center for Financial Research. “In an already tough environment, it gets a little bit more difficult.” The Federal Reserve plans to publish this week a draft of new rules for systemically important financial companies, including banks with at least $50 billion in assets, according to a person with knowledge of the matter.

When you put these two factors together, you can see why BofA's stock price has slid. It's become an expression of investor confidence in BofA's ability to be profitable, at the right levels, in the year to come. A public company's share price is a bit like a crystal ball. It tells you what it's worth today, but it also tells you what it will probably be worth tomorrow.

The nightmare scenario? BofA goes out of business. At this point, however, you have to wonder whether Buffett would be willing to lose his billions on the deal.

Follow Matthew DeBord and the DeBord Report on Twitter.

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