Insights from the failure of the Countrywide Financial Corporation

Abstract

Purpose – This paper aims to evaluate the business activities, financial reports, and management compensation practices of Countrywide Financial Corporation (Countrywide) in the period preceding the company's financial distress and leading to its eventual takeover by Bank of America in 2008. This analysis provides a number of insights into the risks that Countrywide was exposed to which may guide future research and financial management. Design/methodology/approach – Case study evaluating the failure of Countrywide Financial Corporation. Findings – First, Countrywide was highly reliant upon the securitization of mortgage loans to finance its activities and this was apparent in the financial reports. Second, these securitization transactions exposed Countrywide to significant financial risks, including the risk inherent in the uncertain values of residual interests and warrantees. Problematically, these risks were not transparently reflected in the financial reports, as confirmed by the lag in the timing of stock price responses. This untimely market response suggests the equity market was not aware of Countrywide's risk exposures until shortly before the company's solvency crisis. Third, the compensation practices of Countrywide encouraged and rewarded management for exposing the firm to significant risks. Practical implications – This paper provides insights into financial management that are relevant for researchers and professionals. Originality/value – This paper provides insights for researchers and practitioners relating to the impact of asset securitization on business risk and how these business activities and risks are disclosed in the financial reports.