Monday, May 4, 2009

Buffett The Zombie King

Warren Buffett The US Zombie Bank General

Apparently Buffett believes in Madoff banking, he wants the government allowing banks to 'earn' their way out of the problem even if they are insolvent. He said sometime ago he feared the 'government forcing banks to issue stock at very low prices, they can earn their way out of this mess', he is the US zombie banking commander in-chief. For him its not a big deal for the banks to be be critically undercapitalized in a tangible common equity basis(like Wells Fargo) as a long bankers get a chance of to hit again after one of the biggest strike threes in the century. Although its an extreme comparison it resembles the idea of allowing Madoff to keep his company as a going concern and hand him taxpayer subsidies so he can try to 'earn his way' out his hole playing futures

Whats the problem with this approach? Banks wont lend, the latest Fed report on banking lending shows that net credit is down again, the truth is that banks need to be massively overcapitalized(preferably through preferred stock/unsecured debt to equity swaps while respecting property rights)right now so they can feel safe lending again and they can stop using the FDIC deposit and bond guarantees for funding. Banks uncertain about capital will fear their regulators and hurt the lending markets

Buffett claims WFC is a fabulous bank and he would put his entire net worth there I disagree the plain fact is that lots of wells advantages comes from federal subsidies. First the bank is too big to fail, most of the banks with more than $10b in assets pay less in interest for their deposits even though their banking portfolios are worse than smaller banks(Source: FDIC quarterly banking profile). This is the US depositor betting the bigger banks will be saved. Secondly the federal funds rate is at 0% while lending rates are high, this federal subsidy is not sustainable it will reverse eventually, the 'margins' that buffett mentions as one of the great banking assets will decrease at some point. This is a transfer of wealth from savers to banking shareholders, when the economy recovers and banks puts their balance sheet issues behind them they will face as earning issues as the fed raises the rate and banks face massive regulations(along with lower lending rates). Plus there are the FDIC guarantee programs that almost certainly charge a price that misprices its risks(given that they need a bailout themselves), so its a subsidy

Thidly, Obama needled Buffett when the oracle suggested banks shouldn't be forced to issue stock to raise capital 'at very low prices', he said something like 'Buffett is a large player in the financial markets, he is a big shareholder of wells' suggesting he will do the right thing and make banks issue stock and de-zombify them
And finally, there is very little hope banking stocks are something to get excited for the next 10 years

Greater regulation, higher capital ratios(Alan Greenspan is suggesting 15% capital) and a less levered weak growth economy will almost surely hit US banks ROE and therefore stock returns going forward. So perhaps Wells will beat its bank index benchmarks because its a bank that seems to exploit the tendency to get subsidies from the government better than its competition but that doesn’t mean its something to get excited about, it certainly means you wont put a significant part of your networth there due uncertainties, specially with nationalization risk on the table(Maybe Wells Fargo, the company, survives but its possible WFC, the stock, gets destroyed in the process) this is a particulay worry in a undercapitalized bank like wells facing the fat tail risk of 12-14% unemployment

Of course Buffett would object to this saying you cant predict macro/regulatory/economic events, nonsense. Its amazing how someone who makes fun of the efficient market hypothesis turns into a EMH himself when confronted with examples of people predicting macro events for a long time

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