How do you lose $1.2 billion?

Investments are like children: you give them your time and money in the hopes of a potent payoff somewhere down the line.

On Friday Countrywide Financial, America's largest mortgage lender by volume, brought home very disappointing news to the multitude of de facto parents who invested in it.

After 25 years of smooth sailing, Countrywide posted its first quarterly loss... of $1.2 billion dollars.

Now, the few times I did something in retrospect excruciatingly stupid, my step-dad would ask me one simple and direct question: How?

How do you get a $90 late fine on a $70 parking ticket? How do you leave the house with eggs still cooking on the stove? How do you make 329 mobile phone calls to the same number in one month, not including the rest?

Had he invested in Countrywide, he would be screaming “How do you lose 1.2 BILLION DOLLARS?”

Arguably, it’s a rhetorical question. As always, I am going to blindly answer this question with ample technical detail.

Countrywide did not hit a small bump in the road; it helped carve a crater of interstellar proportions in the credit markets with its increasingly irresponsible lending practices. Then, tangled in the subprime mess, it stumbled into the said crater.

"Revenue plunged to a negative $50 million from $2.82 billion a year ago, as the company took a $718 million loss on the sale of loans and boosted its loan loss provision to $934 million from $38 million a year earlier." The Street.com reported

How do you lose $718 million "on the sale of loans"? Well, when inventory turnover lags you find yourself spending more money keeping the loans on the books than what the loans give you in interest payments. So, you net a loss.

To move inventory faster, you might start selling the loans below their value.

Over three months, that can feasibly add up to $718 million when you are America’s largest home lender.

Boosting your loan loss provision over 24.5 times, from $38 million to $934 million, means pulling $896 million out of operations. Obviously, keeping funds in operations is more lucrative than setting them aside for loan loss provisions, or banks would have done away with off-balance sheet transactions a long time ago.

Like most people acutely aware that they’ve done the wrong thing, Countrywide has promised to do better next time. In financial terms, the company has forecast a 25 to 75 cent a share profit for the next quarter.

Meanwhile, the company is paying out a 15 cent dividend. Countrywide is facing a business downturn comprised of a depressed real estate market, volatile credit market conditions that look unfavorably towards buying subprime debt, and an uncertain economic outlook.

If you were running this show, would you a) pay out approximately $86.4 million in dividends, or b) use the money to insure the company’s continued survival?

You can argue that Countrywide is in good enough financial standing to do both. You can point to the fact that this is the first time in 25 years the company posted a quarterly loss.

But you will have to explain the $1.2 billion first.