Here come the vultures

NEW YORK (Fortune) -- Vultures began swooping in Friday to pick over the carnage of the worst housing bust in U.S. history. What's remarkable, though, is how happy the spectacle is making some people on Wall Street.

The day started with Bank of America (BAC, Fortune 500) agreeing to pay $4 billion in stock for struggling mortgage company Countrywide (CFC, Fortune 500). The deal gives BofA the opportunity to build its national brand in the home lending business, which is in steep decline now but is expected to bounce back in coming years. BofA notes that it's getting Countrywide, the biggest mortgage lender in the nation, at a 69 percent discount to its stated book value.

No one wants to pass up that kind of bargain, and there are indications that other big banks are thinking along the same lines. CNBC reported Friday morning that JPMorgan Chase (JPM, Fortune 500) has held talks with Washington Mutual (WM, Fortune 500), another lender that has been hard hit by the housing bust. WaMu recently added a billion dollars to its provision for loan losses to provide a cushion for rising defaults and delinquencies. Like Bank of America, JPMorgan is one of the few giant banking institutions that has avoided having to take big writedowns on souring mortgage-related securities bets - potentially enabling it to look to buy assets on the cheap instead.

The BofA deal and the JPMorgan chatter sent shares higher across the financial sector. The developments offered the latest evidence that while the U.S. banking industry is facing massive losses tied to bad mortgages and losing debt-market bets, troubled companies are still able to raise capital to move forward. Though writedowns and quarterly losses may make for scary headlines, many big financial institutions are still flush with cash after a long economic boom - and looking to put money to work in what they perceive to be unduly punished names.

"Emotional extremes in the market get you emotional highs and lows in prices," says analyst Gary Gordon of Portales Partners in New York. He says we may be more than a year away from any improvement in the health of the housing market and related areas. Yet history shows that steep selloffs in financial stocks deemed risky often later appear to have been overblown. One example often used to bolster this case is the plunge of Citi (C, Fortune 500) stock in the early 1990s into the low single-digits before Prince Alwaleed stepped in with a big investment. Gordon points out that, as in the case of Countrywide, many hard hit financial companies have "real problems, but also real resources."

It's no mere coincidence that the BofA-Countrywide deal came together this week. The move comes as government officials are sounding alarms about the health of the U.S. economy. Federal Reserve Chairman Ben Bernanke took the unusual step Thursday of saying "substantive" interest-rate cuts could be in order. Rate cuts make banking businesses more profitable by increasing the spread between the rates at which banks borrow and the rates at which they lend. That trend, could make distressed financial firms more attractive to buyers.

Lower interest rates won't solve all the industry's problems, of course. The New York Times reported that Merrill Lynch (MER, Fortune 500) could take a staggering $15 billion in losses on its investments in mortgage securities and related instruments. Merrill is expected to outline the full extent of its pain next Thursday, two days after Citi heads to the earnings confessional. Estimates of Citi's mortgage-securities losses range as high as $19 billion. The losses have reportedly put both firms back on the fundraising trail. The Wall Street Journal reported this week that Citi and Merrill are making a second round this month of the sovereign wealth funds that underwrote their capital-raising pushes in December.

And even if money is available, some firms are finding it comes at a steep price. Take bond insurer MBIA (MBI), which has been pilloried over the past year amid worries that rising defaults will leave it with massive losses. The company agreed last month to raise $1 billion in a stock sale to private equity firm Warburg Pincus. Since then, MBIA shares have lost more than half their value, prompting one fan of MBIA to complain this week that "the baby is getting thrown out with the bathwater" because of an ill-advised argument that the firm faces liquidity problems. The news seemed to get worse Friday, when Reuters reported that the company may have to pay investors as much as 14 percent to swallow a $1 billion surplus bond issue - double what might be expected of a company with MBIA's triple-A credit rating. Yet despite the setbacks, MBIA shares surged 18 percent Friday on the Countrywide news. Rarely have circling vultures made so many people happy.