Professor Elam

Plea read Mario Bartiromo’s interview with Ken Lewis, CEO of Bank of America.  You will recall that Bank Of America BAC bought Countrywide Finance CFC with a stock purchase. That is ,they exchanged .18 shares of BAC stock for CFC stock.  Previously B of A had invested $2 Billion in CFC. Maria asks if BAC felt it had to purchase CFC to protect its original $2 B investment. Why did Maria ask that question?

This sets up a discussion of the order of creditors.  It is necessary to understand that to grasp the importance of her question.  It might be a good idea to go back and read my post from 1/5/08.  This presents the order of creditors in liquidation.  But the point is the BAC purchased a stake in CFC with preferred stock. So they will be paid before the common stock holders. BAC research indicated that there was enough good assets that even with more sub prime write offs, there would be adequate assets to pay them off, though probably in kind in my opinion.  I am suggesting that BAC would likely get the mortgages rather than cash in such a bankruptcy of CFC.  I made the point in  Intermed ACCT 3120 that preferred stock made sense for a bank to issue as it did not have to be re paid and offered financing at a fixed fee.  The other side of the coin is that it makes sense as an investor because one stands in line at the liquidation window before the common stock holders.

Maria also asks if Ken thinks CFC will go bankrupt, ie, before the transaction is concluded. He says no.  Well CFC closed Friday at $4.93 down from over $40 a year ago. That is a loss of over 80% of the stock’s value. Okay, now, how much equity loss in the overall stock market doe that represent?  How much ‘paper wealth’ has evaporated in the last year? How would you calculate that?  Can someone post an answer to that question here on the blog?