Wednesday, April 22, 2009

Tangible Common Equity

Every since Mr Market decided suddenly that Tangible Common Equity (TCE) was THE measure of a bank's health a couple of months ago I've been well...amazed. It's another great example of how some investors and media outlets can just grab onto something whether or not it makes sense.

Some think TCE is the focus of the bank stress tests. If it turns out the basis of the stress testing is to use this simplistic and flawed measure of bank health -- and, as a result, some of the better banks are forced to raise lots of capital at a discount to per share value -- that will be unfortunate.

Just a guess but I think we will find out the tests look at a more comprehensive set of measurements.

In this interview in Fortune Magazine, Warren Buffett had this to say about TCE as a measure of bank health:

"You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where’d the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've (Wells) got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently." - Warren Buffett

We should know the answer soon.


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