The government today announced a plan to backstop Bank of America against mounting losses driven in part by its acquisitions of Countrywide Financial Corp. and Merrill Lynch, as the bank reported a $1.79 billion fourth-quarter loss.

The Treasury, Federal Reserve and FDIC are providing loan guarantees, access to liquidity and capital to Bank of America, including protection against any "unusually large" losses on $118 billion in loans mostly acquired in Bank of America’s acquisition of Merrill Lynch.

Under the plan, Bank of America would cover the first $10 billion in losses and the government would cover 90 percent of any subsequent losses, with Bank of America paying a premium of 3.4 percent on assets covered by the program.

The Treasury will also invest $20 billion from the Troubled Assets Relief Program in Bank of America in exchange for preferred stock paying an 8 percent dividend to the government.

Bank of America, which moved up reporting of fourth-quarter earnings after news of massive government assistance leaked Thursday, said it was cutting its dividend to shareholders from 32 cents to one penny. The bank said Merrill Lynch, which it acquired Jan. 1, saw a $15.31 billion net loss during the fourth quarter.

The government reportedly agreed to provide a backstop to Bank of America in order to prevent the bank from pulling out of its acquisition of Merrill Lynch — an event that could have caused repercussions throughout the financial system similar to the failure of Lehman Brothers.

Some economists have criticized the government’s decision to let Lehman Brothers Holdings Inc. fail as the event that turned the credit crunch into a financial crisis. Bank of America announced its plan to acquire Merrill Lynch on Sept. 15, the same day that Lehman Brothers filed for Chapter 11 bankruptcy (see story).

The turmoil on Wall Street and government intervention on behalf of lenders and mortgage markets has meant lower interest rates for homebuyers with good credit, but any benefits for housing markets could ultimately be outweighed by mounting unemployment and the prospect of a prolonged recession.

The debt the government is taking on to head off a collapse of the financial system could ultimately lead to inflation and higher interest rates when a recovery does take place.

"I think two years down the line, we can expect fairly significant inflation," said Leslie Appleton-Young, chief economist for the California Association of Realtors, speaking at a panel discussion at the Inman News Real Estate Connect conference in New York City last week.

In a speech this week at the London School of Economics, Federal Reserve Chairman Ben Bernanke touched on the Fed’s "exit strategy" for unwinding its lending programs in a smooth and timely way once the crisis has passed to avoid fueling inflation.

Higher mortgage rates can reduce the purchasing power of homebuyers, depressing home prices. But inflation can also boost home sales, especially when interest rates lag. That’s because homes are seen as a better hedge against inflation than some other investments, particularly after tax breaks for owner-occupied properties are factored in.

For now, lower interest rates have meant a surge in refinancings, but there’s less interest among buyers in taking advantage of low rates. Refinance applications accounted for 85.3 percent of all mortgage applications during the week ending Jan. 9, the Mortgage Bankers Association reported this week (see story).

Bank of America said it extended $115 billion in new credit during the fourth quarter, including $49 billion in commercial non-real-estate loans, $45 billion in mortgages, and nearly $7 billion in commercial real estate loans. Bank of America said it also granted nearly $8 billion in credit card and unsecured consumer loans, and $5 billion in home equity loans.

Bank of America also said Countrywide modified approximately 230,000 home loans during 2008, after embarking on a home loan modification program intended to keep up to 630,000 borrowers from losing their homes to foreclosure.


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