Debunking Conspiracies

So there seems to be a lot of hoo-hah about the Fed bailing out Countrywide under the guise of Bank of America, blah blah blah, tin-foil hat nonsense.

First, the facts from Bloomberg: Countrywide Rises on Bank of America Stock Purchase.

Countrywide Financial Corp. rose about 1 percent after Bank of America Corp. bought $2 billion of preferred stock in the company, erasing concern the nation's largest mortgage lender will go bankrupt.

Bank of America, the second-biggest U.S. bank by assets, gets shares that yield 7.25 percent and can be converted into common stock at a price of $18, Countrywide said yesterday in a statement. The shares are convertible at any time, though Bank of America will be subject to trading restrictions for 18 months, according to a regulatory filing by Countrywide today.

OK, now let's roll up our sleeves, and dig in to how this works.

Imagine you're Mozilo (CEO of Countrywide). You're in deep doo-doo. You need money badly, and you need the money now. So you make this deal.

What's in it for BofA?

They give Countrywide $2B, and get bonds yielding 7.25%. They can be converted to roughly 111 million shares ($2B / $18). So here's what BofA will do. They will short 111 million shares right now which will yield them roughly $2.4B on the open market ($22 share price right now.)

Now, you get the coupons from the Countrywide preferred, and the $2.4B you just netted.

Please note that this deal is "self-financing". You gave them $2B and netted $2.4B right now.

There are two scenarios:

If the company goes bankrupt, and the stock goes to zero, you just made a $400M bundle plus you get coupons till they die. You also get first picking over the carcass of the company before anyone else. Not bad for a day's work.

If the stock survives, and the stock rises, after 18 months, you can always exercise the convertible right, get the stock at $18, and you've made $400M plus all the coupons until you exercise the rights. Not bad either.

What's in it for the CEO?

The company lives to fight another day. If the executives and the board are smart cookies, and I assure you they will be, they will cash out all their options, stock, etc. and fuck the hell off.

Well, then since there are no free lunches, somebody must be getting screwed. That would be the current stockholders, and also the current bondholders. (If I were either of them, I'd get the fuck out of this piece of shit pronto!!!)

See? No conspiracies needed to explain this lipstick on a pig?