UPDATE 4-Countrywide plunges on downgrade, bankruptcy fear

(Recasts, adds closing bond prices)

By Jonathan Stempel

NEW YORK, Aug 15 (Reuters) - Countrywide Financial Corp. CFC.N shares sank 13 percent, their biggest one-day decline since the 1987 stock market crash, on fears the largest U.S. mortgage lender could face bankruptcy as liquidity worsens.

"If enough financial pressure is placed on Countrywide or if the market loses confidence in its ability to function properly, then the model can break, leading to an effective insolvency," Merrill Lynch & Co. analyst Kenneth Bruce wrote. "If liquidations occur in a weak market, then it is possible for Countrywide to go bankrupt."

Countrywide debt prices fell and the perceived risk of owning its bonds rose, suggesting less confidence that the Calabasas, California-based company can pay its bills and fund operations.

This helped drag down U.S. stocks [nN15285446], as investors bought safe U.S. government debt [nN15600290] to escape clouds enveloping the U.S. mortgage industry.

Bruce downgraded Countrywide to "sell" from "buy" on Wednesday. "The company can survive a period of secondary market instability; however, the steps that it would take to preserve shareholder value would be expensive, likely leading to further share price declines," he said.

Shares of Countrywide closed down $3.17 at $21.29 on the New York Stock Exchange. They have fallen 50 percent this year, and the company's market capitalization has dropped to about $12.3 billion. Countrywide did not immediately return requests for comment on Wednesday's share price decline.

Bruce's downgrade suggests deepening problems at Countrywide, which has in the last month tried to assure investors it would thrive once the credit crunch afflicting U.S. mortgage lenders passed.