Banks To Get Huge Windfall From. . . Mortgages?

No, you haven't just woken up from a terrible dream to realize it's still 2005. This is current news that mostly got lost in today's other news. An interesting article from Bloomberg today explains how some of the big banks who made major acquisitions, like JP Morgan (Washington Mutual), Wells Fargo (Wachovia) and Bank of America (Countrywide) will reap huge profits from the mortgages held by the trouble institutions that they purchased.

From the article:

JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks' balance sheets and the cash flow they're expected to produce.

How is this possible? Turns out when they purchased these banks, they marked those mortgages down even lower than what they turned out to be worth. As a result, those mortgages will end up performing better than where they were valued at acquisition. That means a huge accounting profit.

Ever since I took accounting many years ago, I always thought it seemed like a game. Looks like I was right. This situation raises the question: if these banks had properly valued those mortgages, would they have needed the huge bailouts that they were provided? After all, JP Morgan, Wells Fargo and Bank of America got $25 billion each. Their windfall might cover most or all of that according to this article. That also means many of those mortgage-related write-downs taken last year will probably be erased by these profits.