Print
Hits: 10939

 

modern_day_bank_run_northrock.gif
We actually had a modern day run on the bank in the UK and the equity markets shrugged it off.
It is a mistake, plain and simple. I normally don't like to tell people who specialize in a business how to run it, since they probably know more about their business than I do - but sometimes the mistakes are just so glaring. I don't care how many analysts are poring over how many books at Countrywide. BAC's error is not misjudging the value of Countrywide now, but misjudging the macro environment in which Countrywide operates.

 

My experience has been primarily understanding and evaluating companies from the equity perspective, but that definitely doesn't mean that I ignore the fxed income side. I am just not better at it than the other guys. What I have been noticing of late is that credit markets have been screaming murder for some time now, and the equity markets have been humming along new bullish highs and trading runs as if nothing is truly wrong. This is a strong indicator that momentum trading has again taken control of the markets. It is an environment where price trumps value. The last time this came to a head was the dot com bust. It took many institutional and individual investors 5 to 6 years to break even. Some never recouped their losses. Well, my gut has been telling me for about a year and change now that we are back there again. 2008 thus far has done nothing but confirm that we have come to a head. The pic above was an actual shot (one of very many at various locations) of the run on Northern Rock Bank in the U.K. This was real, and it was indicative of a real problem.

Well, we had a very recent run on the bank here in the states as well. There were pictures all over the web when it occurred, and now mysteriously, they are all gone. All I was able to retrieve was this screen capture of a thumbnail from Blownmortgage.com. Just as the pictorial remnants of the run have somehow disappeared, so has the equity markets prudence in the face of such a run. You can guess which bank got ran on.

 

cwide_bankrun.png

There were companies in the dot com era that made purchases that they thought were risky but potentially profitable, and in more severe cases such as the internet media companies, many have dwindled down to mere pennies per share, ex. Razorfish, et. al. So, historically, companies have had the hubris of BAC to go on and lose most or all of thier investment.

I have been using this chart a lot lately, and it looks like I will be using it a lot more.

If the housing market goes anywhere NEAR its historical trends, we are going to see 30% to 40% drops in real prices. Many people poo-poo this notion, calling it apocalyptic. This is silly to me. Why didn't they poo-poo the notion of 40% to 200% price increases in the same time frame? Isn't that even more dramatic? For some reason, investors - individual and professional alike - have a hard time avoiding following the crowd. They try to catch bottoms (a risky and foolhardy endeavor in my opinion), time tops, and always seem to believe something will bounce back or XYZ asset will never go down in price over the long term (ala Fitch Ratings HPA models or the Japanese real estate market).

 

But BAC is Value Investing Like Buffet

No they are not. They are gambling like cowboys. The caveat to the Buffet argument is that BAC didn't buy the assets of Countrywide, they bought the whole company, kit and kaboodle - including the liabilities. I can understand if they bought just the servicing arm, but they didn't. Believe me, it is possible to pay less than zero for a company. The last time Buffet bought a financial company steeped in liabilities and risks on the cheap, he regretted it and realized that no matter how cheap he got the assets, he still overpaid. Risk vs. Reward: don't just stare at the reward side of the equation. If you must, simlpy reminisce on Solomon Brothers. In other words, the cost for buying Countrywide could easily be more than what is paid for it.

CFC is dangerous, plain and simple. The residential housing chart clearly shows how far out of whack housing values are in historic real terms. Come on, this makes the remnants of the Gold Rush look mild. If values come anywhere near the mean values of growth, BAC will be paying the CFC bill for a long time, and they will be paying a lot more than $6 billion, the cost of acquisition. Now, I hear there are performance covenants and guarantees in the purchase which may smooth out the pain, but CFC is in a world of hurt, and doesn't have much wiggle room to offer incentives. As I have stried my best to insinuate, it is possible to get CFC for free and still lose money. I know BAC has been in the business longer than I have been short CFC, but I made more money on that short than they did on their $2 billion investment. Sometimes, you are just wrong.

As of last month, CFC had more nominal dollars in REOs than they did market cap. Now, just add all of those garbage loans, the plethora of law suits, a few SEC and state banking authority investigations in a pot with a market where housing value corrects 30% in real terms with inventory building higher and higher, and we have a bitter tasting brew indeed... I hope those BAC shareholders have strong stomachs.