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August 19, 2007

Bank run at Countrywide Financial Corporation Good for Bank of America

posted by MR WAVETHEORY at 8/19/2007 09:21:00 AM
A bank run (also known as a run on the bank) happens when every depositor tries to pull their money out at the same time. There is a bank run happening right now at Countrywide Financial Corporation (NYSE CFC).

The rush to withdraw money -- by depositors that included a former Los Angeles Kings star hockey player and an executive of a rival home-loan company -- came a day after fears arose that Countrywide Financial could file for bankruptcy protection because of a worsening credit crunch stemming from the sub-prime mortgage meltdown.

The parent firm borrowed $11.5 billion Thursday by using up an existing line of credit from 40 banks, saying the money would help the lender meet its funding needs and continue to grow. But stock investors, apparently alarmed that the company felt compelled to use the credit line, sent Countrywide's already battered stock down an additional 11%.

What is bad for Country Financial Corporation could turn out to be a blessing for Bank of America (NYSE BAC).

Bill Ashmore drove his Porsche Cayenne to Countrywide's Laguna Niguel office and waited half an hour to cash out $500,000, which he then wired to an account at Bank of America.

My advice: if you've got money at Countrywide, don't walk, run to the bank.

Bank runs were quite frequent during the pre-Federal Reserve era because there was no lender of last resort. This is what happened during the Great Depression in 1929 as thousands of banks failed. At the beginning of the Depression, in 1929, there were close 25,000 banks in America. In 1934, the number of banks in America had dwindled to 16,000.

Numbers of Banks and Bank Suspensions
Year
Number as of 12-31
Suspensions
1929
24,633
659
1930
22,773
1350
1931
19,970
2293
1932
18,397
1453
1933
15,015
4000
1934
16,096
57

Data are from Table V 20-30 in Historical Statistics of The United States: Colonial Times to 1970, 1975, p. 912.


When the banks failed, depositors lost their savings. The banks failed because they ran out of cash. Why? It's the business model of banks to lend out more money than they actually have - called the multiplier ratio. In fact, that's why banks are such good businesses. They lend what they do not have to borrowers and borrow what they do not own from depositors.

Today, there are roughly 7,500 banks in America. No depositor has lost a single penny of insured funds according to the FDIC since 1933. The catch is that depositors are only insured up to $100,000 by the FDIC and FDIC insurance is fairly worthless if you need rapid access to your cash. History is a good teacher. In the 80s, when companies like World Savings and Loan failed, depositors waited for years to get their money back.

So, don't walk, run to your bank!

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4 Comments:

Blogger mshearer said...

Check out www.eyeoncountrywide.info, an independent consumer resource examining sub-prime lending and Countrywide Financial Corporation

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