The Breakdown | Explaining Southern California's economy

Bank of America saved by Warren Buffett – for now

Bank of America’s stock price has dropped by 50 percent since the beginning of year, amid speculation that it was confronting additional write-offs related to subprime mortgages, wanted to unload investment back Merrill Lynch (no takers), might be merging with JP Morgan Chase, and was facing a capital crisis that caused investors to strongly suspect that the bank wasn’t muddling through the economy’s current soft patch but was in fact insolvent. Treasury Secretary Tim Geithner was prepping the bailout! Game over was just days or weeks away!

Three bloggers created a kind of tag-team to parse the meltdown of the country’s second-biggest bank. Yves Smith at Naked Capitalism (who had already started a B of A Death Watch) and Zero Hedge drilled into the numbers, while Henry Blodget at Business Insider summed it all up, was attacked by B of A for talking smack about the true value of the bank’s assets, and then proposed that the government closely monitor B of A’s slide, taking it over once it falls beneath a certain threshold and restructuring it to prevent a Lehman 2 event that would bring down the U.S. and probably world economy:

The new solution we have proposed is much more akin to the "Swedish solution," which acknowledges that Bank of America is 1) systemically important, 2) has forfeited the right to solve its problems itself (by virtue of losing investors' confidence), and 3) will never solve its problems voluntarily (as evidenced by its failure to solve it over the past two years).

This solution is similar to the General Motors solution—the one that many people said was inconceivable at the time. (Note that GM is now fine and no longer our problem). It's not a "bailout." It's a rapid restructuring.

There were other scenarios outlined, including allowing B of A to put Countrywide into bankruptcy, then using the bankruptcy as a pretense for regulators to take control of the bank.

Then Warren Buffett stepped in. Today, he put $5 billion into the bank, which was enough to arrest the slide and stabilize the stock. Buffet has had a lively couple of weeks. First he took to the pages of the New York Times to demand that rich people pay more taxes. Now he’s acting like a modern-day J.P. Morgan, stepping in to rescue B of A just as he rescued Goldman Sachs during the financial crisis.

This is all highly relevant to Southern California because, as I pointed out in an earlier post, channeling KPCC business commentator Mark Lacter, B of A is huge here. It has $200 billion in retail deposits in SoCal alone. All backed up to legal limits by the FDIC. And forgetting that Buffett has engineered what appears to be a sweet deal whose risk is underwritten by the government’s continuing “too big to fail” policy, there’s still trouble ahead. Here’s Yves Smith:

The bulls’ hope is that BofA will have enough time to earn its way out of this mess. But if a Eurocrisis hits, and this looks like a sooner rather than later event, investors will avoid risk first and think critically later. The real determinant is whether this gambit does much to bring in Bank of America’s CDS spreads, which were trading at higher-than-Lehman-before-its-failure levels.

That bit about CDS (credit default swap) spreads means that those who are worried about B of A collapsing are more worried than they were about Lehman collapsing in 2008. You remember how that went, right? If those spreads narrow, it will mean investor confidence has been somewhat restored in the bank. Restored enough, at any rate, to prevent federal regulators from paying B of A CEO Brian Moynihan a visit after the market close on a Friday.

None of this means that B of A won’t fail. However, Buffett has performed his savior-of-capitalism role yet again and at least bought us all some time. For which he will be handsomely compensated.

Photo: Wikimedia Commons