Is Bank of America Headed Toward Collapse?

Bank of America is no stranger to controversy. The largest bank in the United States has seen, in just the last six months, nationwide protests of its branches by groups like US Uncut, National People's Action and other progressive activists angered by the company's tax dodging, foreclosures, massive bonuses (paid after taxpayer bailouts) and other practices.

But could the too-big-to-fail behemoth actually be headed for failure?

On August 5, Yves Smith of the blog Naked Capitalism started a Bank of America Death Watch, writing:

“It is clear that the Charlotte bank has too much in the way of legal liability that it will not be able to shed and yet-to-be-taken writedowns on balance sheet items (for instance, roughly $125 billion of home equity loans and junior liens on residential real estate as of end of last year) for it not to be at risk of a death spiral.”

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Back in 2008, Bank of America snapped up Countrywide, one of the subprime lenders that preyed on low-income home buyers, often with adjustable-rate mortgages that ballooned after a couple of years, leaving homeowners unable to make payments. Though it doesn't seem hard to figure out that many people would be driven into foreclosure by such loans, Countrywide was able to repackage these loans into mortgage-backed securities that were then resold as prime products to investors—investors that often were state pension funds, like CalPERS, the funds responsible for paying the benefits owed to public employees. These are the same public employees who are now being targeted around the country as greedy and unwilling to take cuts to their pensions. The unethical actions of big banks and mortgage lenders are at fault, yet working people are expected to take the hit.

“Countrywide exploited the American dream of homeownership,” then-state attorney general, now California governor Jerry Brown said when he announced his state's lawsuit against the lender. “Countrywide was, in essence, a mass-production loan factory, producing ever increasing streams of debt without regard for borrowers,” he said. “Californians…were ripped off by Countrywide's deceptive scheme.”

As part of a massive settlement of Countrywide's practices, Bank of America was supposed to modify loans to help keep people in their homes, but it's all too often claimed the right to foreclose instead. Meanwhile, if borrowers happen to default again on a modified loan, B of A could profit from tacking added fees to the bill its investors are expected to foot.

But a wrench was thrown into B of A's plans this summer. In June, the bank announced an $8.5 billion settlement with investors, but New York's attorney general Eric Schneiderman, filed a motion to intervene. He called the settlement “unfair and inadequate,” and alleged “fraudulent and deceptive conduct” on the part of Bank of New York Mellon, which is the trustee in this case—supposedly acting on behalf of investors, but, Schneiderman alleges, possibly making a deal with Bank of America that gives the big bank the far better end of the bargain.

Schneiderman, unlike many government officials on the state and federal level, took the step of intervening because signing off on the settlement might affect his ability, later, to file charges against any of the companies involved.

As David Dayen at FireDogLake noted, the suit alleges that Countrywide sold what amounted to non-mortgage-backed securities to those investors. It reads:

“These provisions are central to any mortgage securitization, but they are now vitally important to trust investors in light of the housing market collapse. Any action to foreclose requires proof of ownership of the mortgage. This must be demonstrated by actual possession of the note and mortgage, together with proof of any chain of assignments leading to the alleged ownership. Moreover, complete mortgage files give borrowers assurance that their properties are properly foreclosed upon. The failure to properly transfer possession of complete mortgage files has hindered numerous foreclosure proceedings and resulted in fraudulent activities including, for example, 'robo-signing.' These fraudulent activities have burdened borrowers as well as the courts with flawed foreclosure proceedings.”

Robert Scheer pointed out that Schneiderman stepped up when everyone from the White House on down was willing to sign off on a sweetheart deal that would “complete the job of saving the banks while ignoring their victims.” Schneiderman deserves credit for his fight, and also has some powerful tools on his side as the New York AG; the Martin Act, which, as Scheer quotes the Wall Street Journal, is “one of the most potent prosecutorial tools against financial fraud” because it doesn't require the AG to prove intent to defraud.

“There are so many people who got bad deals and are stuck with those bad deals that are just seething at the sense that the bankers who put them in the bad deals aren't stuck with the deal,” Schneiderman said. “They’re not stuck with taking responsibility for this.”

Now Delaware attorney general Beau Biden (the son of Vice-President Joe Biden) has joined in the petition against Bank of America's settlement, noting the massive conflict of interest on the part of Bank of New York, and claiming his right to intervene and protect Delaware investors.

Yves Smith commented, “The fact that the rule of law is not completely dead in the US is looking increasingly likely to provide a very costly lesson to some very large banks and their asleep at the wheel regulators.”

While the intervention in this settlement by a couple of determined attorneys general certainly isn't enough to sink B of A, that's hardly the only problem facing the bank that many progressive groups call “Bad for America.”

Also this week, AIG (yes, the same AIG that helped kick off the financial crisis with its own toxic financial business) filed suit against B of A for $10 billion in losses, making it “possibly the largest mortgage-security-related action filed by a single investor,” according to Gretchen Morgensen and Louise Story at the New York Times. The suit claims that B of A and its subsidiaries Countrywide and Merrill Lynch misrepresented the quality of the mortgages sold as securities to investors—the same subprime mortgages that created and then popped the housing bubble.

Morgensen and Story note that while the Justice Department has brought only three cases against employees at large banks and none against executives, private suits are still a possibility. AIG might have been part of the cause of the economic crisis, but at the moment it is still mostly owned by taxpayers (you and me) thanks to the bailout back in 2008. Kathleen C. Engel, a professor at Suffolk University Law School in Boston, told Morgensen and Story, “To the extent there are places where shareholders and borrowers can pursue claims, they are really serving the function of the government. They are our private attorneys general.”

These suits, and the possibility of others down the line, are creating bigger headaches for Bank of America that it seems to have foreseen when it bought one of the biggest purveyors of toxic mortgages. “Obviously, there aren't many days when I get up and think positively about the Countrywide transaction in 2008,” Brian Moynihan, Bank of America's CEO, said in a conference call last week.

There are indications that investors and customers are also betting against Bank of America. Credit default swaps—mechanisms by which investors protect against default on a loan by purchasing insurance against its default, thereby hedging their bets—against B of A surged recently to their highest since April of 2009. The difference between a credit default swap and traditional insurance is that you don't have to have any financial interest in the loan in question—so they effectively become a form of gambling on default. Smith noted that B of A had a near-death experience back in 2009 as well, but wasn't forced to make any significant changes to its operations. Until Schneiderman intervened in the foreclosure settlement, B of A was allowed to keep functioning in essentially the same way it had before the financial crisis, when taxpayer bailouts had to keep it from falling apart.

And of course, with all those public protests against B of A's practices, Smith pointed out that the bank has been steadily losing depositors, as customers move their money to different banks that have less of a reputation for shady dealings.

So when, on Thursday, a mainframe computer malfunction in the Los Angeles area left customers unable to access their accounts, Demos fellow and former Wall Streeter Nomi Prins tweeted “Yesterday, BofA says it doesn't need to raise more capital, today its CA systems fail, thereby clamping down on capital. probably unrelated.”

Whether or not the Los Angeles computer glitch had anything to do with B of A's financial troubles, the bank is likely to see its problems magnify. The entire financial market took a hit over the past couple of weeks, and the bank's current legal troubles may be only the beginning. Jack Barnes at Money Morning called Bank of America “A house of cards on the verge of collapse.” With a double-dip recession looking increasingly likely, a giant, undercapitalized beast like Bank of America looming over the economy like a bomb waiting to go off should scare everyone.

Christopher Whalen at Reuters wrote “[Bank of America] is a too big to fail zombie created by the Obama administration and the Fed to protect US financial markets, but is now so vast and unstable that it threatens the global economy,” and argued that the best way to deal with it is to put it through a restructuring under the Dodd-Frank legislation.

In other words, for the FDIC to take control of the bank, proceeding like a regular bankruptcy but protecting depositors before creditors of the bank.

As we learned with the first round of financial crises, the government was unwilling to let the big banks go under, preferring to save giant institutions and hope that their largesse would trickle down to depositors and borrowers. They also proved unwilling to break up those giant institutions—in many cases, like that of Bank of America and Countrywide, putting multiple too-big-to-fail entities together to create an even bigger, more dangerous monster that could have serious impact on everyone if it goes down.

If Bank of America does wind up in the death spiral Smith and others predict, are taxpayers going to find themselves on the hook for another bailout? Is there hope in the interventions of AGs Schneiderman and Biden, that perhaps some government officials will put people before massive corporate profits, and hold the people at the root of the economic crisis responsible for their dealings? Only time will tell.