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Is Countrywide Slowly Killing Bank of America?

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As solvency issues swirl around the Charlotte-based behemoth, it appears BofA didn't quite get the deal of the century when it acquired Countrywide.

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In January 2008, when Lehman Brothers was still a company and Washington Mutual (JPM) was still making loans, I wrote of Bank of America's (BAC) recent Countrywide acquisition, "Did Bank of America get the deal of the century or the biggest headache in recent financial history?" (See Will Countrywide Sink Bank of America?)

As solvency issues swirl around the Charlotte-based behemoth, it appears the latter assessment was correct about then-CEO Ken Lewis' big bet on Countrywide's mortgage business.

At the time of the acquisition, Countrywide held $80 billion in mortgages for investment. Eighty percent of those, according to the Wall Street Journal, were either second liens or pay Option Arms. And remember, that was early 2008 when the financial crisis was still in diapers. Losses mounted, quickly eating up the discount BofA received on the purchase of what was once the nation's largest private mortgage lender.

But investors can quantify asset writedowns. They may guess to high or too low, but as conditions change so can assumptions about losses. It's fear of the unknown that spooks investors and causes liquidity scares like the one Bank of America is now so ardently fighting. In buying Countrywide, the bank inherited legal liabilities that while vaguely understood at the time, have only now truly become fully realized.

In the fall of 2008, as the fate of the financial world was anything but certain, Bank of America agreed to pay a whopping $8 billion in damages to 395,000 borrowers stemming from Countrywide's shading lending practices. And the litigious party was just getting started. (See Banks Beware: Here Come the Lawsuits)

Just this year, Allstate Corp (ALL) sued Bank of America over $700 million in mortgage securities it bought from Countrywide; a group of institutional investors including BlackRock (BLK) and New York Life Insurance Corp rejected an earlier $624 million settlement stemming from bad Countrywide loans; and most recently AIG (AIG) sued the bank over damages of more than $10 billion caused by Countrywide securities in which AIG invested.

Bank of American lashed out at AIG, alleging that the firm "recklessly chased high yields and profits." AIG countered that "Bank of America continues to attempt to blame others for its own misconduct." But now that taxpayer money is on the line in the form of a lawsuit from AIG, its a safe bet this suit will not go away quietly.

What's really spooking investors, in addition to questions about the value of Bank of America's assets, is what other legal liabilities are yet to surface. You can't price what you can't see, and if you can't see a $10 billion lawsuit that hits the wires on an otherwise ordinary Monday morning, you're forced to assume its just one of many coming down the pike.

Thanks to Countrywide's questionable lending, the unfortunate reality for Bank of America is that it probably is.

Twitter: @schnageler

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No positions in stocks mentioned.

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