Tuesday, February 24, 2009

Business News

Some stocks I like @ or below the prices listed for my own portfolio.*

These are all long-term investments. A ten year horizon or longer.

No trades here.

Stock/I'd buy @ or Below this Price/Recent Price**
JNJ/65.00/53.65
COP/50.00/37.58
KFT/30.00/22.96
USB/24.00/11.33
WFC/28.00/11.03
BNI/80.00/59.06
KO/55.00/42.09
PG/60.00/48.90
AXP/35.00/12.15
PEP/60.00/50.16
ADP/37.00/34.25
DEO/60.00/48.05
PM/45.00/35.11
BRKb/3000/2360
MO/16.00/15.05
LOW/19.00/15.09
MHK/30.00/26.65
PKX/80.00/53.30
RMCF/6.00/5.76
--------------------
HANS/25.00/32.07

More on this in a follow up.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything. Generally have already established -- or intend to establish if prices remain low enough -- long positions in the above stocks.
** As of February 23rd.

Saturday, February 21, 2009

Follow the Cash

Examining the cash flows of a business helps to cut through the noise. It's easy for accounting to distract from the crucial economic characteristics of a great business. As an example, Buffett in his 1983 letter to shareholders, explains the difference between economic and accounting Goodwill.

With this in mind, I'd like to consider something Dick Bove said Friday in an interview on CNBC that seemed to get very little attention.

In the interview, Dick Bove states that banks do not have to be nationalized and if people would focus on cash flows in the US banking industry they would understand that. Bove goes on to make the point that the pretax cash flows of the US banking industry were actually $ 59 billion in the most recent quarter....but this cash earning power was reported as only $ 1.5 billion of pretax operating earnings on an GAAP accounting basis. 

First of all, I think most industries would like to earn that much cash in a good year (never mind in such a tough environment). Naturally, it is fair game to challenge Dick Bove or any analyst on such an important number. I personally have a similar view. Banks are going into a very difficult period but the largely incorrect perception of imminent trouble has turned a serious but manageable situation into a crisis. Banks will need some time for their cash flows to absorb growing credit losses. Those huge cash flows over time and regulatory forbearance can fix most of the banks (the US auto industry has no such luxury). The situation is not unmanageable.

Yet.

The term credit comes from the Latin credere meaning "to trust or believe". Allowing the belief that banks are going over a cliff to persist when they are not does real franchise damage to the banks and, most importantly, material economic damage to the US.

We are all participants in a potentially self-fulfilling but largely unnecessary outcome.

Finally, mark-to-market is only a part of this problem but it does make the situation worse. In some sense, this is more about the inherent limitations of accounting in my view.

Always...follow the cash.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, February 16, 2009

$ 9 Trillion of assets exists within the Top 4 US banks...but NYT article says FDIC struggles to manage just $ 15 billion

Combined, the two articles below make an inadvertent, but important, point. There seems to be a "scaling error" being made by many economists and other experts. Engineers have developed methods to prevent bridges from collapsing and computer systems from crashing due to scaling errors. Biology also has lessons on scale. A mouse cannot be scaled to the size of an elephant without a "re-design". The legs (even if scaled up proportionally) will collapse. Things that seem to work on a small scale do not necessarily translate when done on a larger scale.

Some economists apparently have no such methodology.

Here is the central concern: According to the second article, the 4,800 or so FDIC employees are "struggling to manage $ 15 billion worth of property left from failed banks". If this is true...how is the government going to manage the $ 9 trillion plus contained within the 4 largest banks as Roubini and others suggest? That's an instant six hundred fold increase in assets that the government would need to be ready to handle. Many of these assets are held in entities located outside the US. Where's the army for this going to come from? Does anyone doubt it would be a bit unwieldy to manage?

First article from NYT

Failed Banks Pose Test for Regulators

"...the agency, which had shrunk to a relatively tiny 4,800 employees from as many as 15,000 in the last period of bank meltdowns in the 1990s, is in the midst of a military-scale buildup as it undertakes one of the greatest fire sales of all time.
The agency is frantically calling in retirees and holding job fairs, looking to hire as many as 1,500 people. It has rented a high-rise office building in Irvine, Calif., the new headquarters for a West Coast branch of 450 employees who are wrestling with a real estate crisis in one of the hardest-hit regions. It is also budgeted to pay hundreds of millions of dollars for a small army of contractors to augment its staff."
---
Second article from the Washington Post

Nationalize the Banks! We're all Swedes Now


"The government should start with the big banks that have outside debt, and it should determine which are solvent and which aren't in one fell swoop, to avoid panic. Otherwise, bringing down one big bank will start an immediate run on the equity and long-term debt of the others. It will be a rough ride, but the regulators must stay strong. Second, immediately nationalize insolvent institutions."

For a variety of reasons, I'd argue that as a result of these large scale nationalizations, the remaining US banks would also fail so even more resources would actually be required.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

U.S. Banking Crisis: Should Banks Be Nationalized?

Nationalizing banks has been required at times throughout economic history. I accept that to a point. 

Some think nationalizing banks makes sense right now.

Nationalize the Banks! We're all Swedes Now

Well, in a different context, maybe, but not this time.

Why? Here's a couple of reasons:

1) Scale - It's one thing for a government -- even one as large as the U.S -- to take over banks with just $ 10-20 billion in assets but there is more than $ 7 TRILLION in our top four banks. This New York Times article suggests the FDIC is struggling to manage just $ 15 billion of bank assets.

The government lacks the capability, resources, and incentives to fix and operate these rather large and complex institutions.

2) Disincentives - The disincentives that nationalization (and the threat itself) creates for fresh capital is very real. It would likely chill the capital formation that's needed on a big scale. In fact, it just might divert equity capital away from the U.S. banking system for years to come. Those who think that's not a big deal should feel free to nationalize away. I'm not in that camp. My view is it would be terribly damaging to the private equity capital formation process for banks. That just makes the system inherently weaker than it needs to be.

I'm certainly okay with some intervention, but any intervention should encourage private equity capital formation and enhance liquidity. There's a sensible way to go about this short of nationalizing the banks.

Keep in mind that some of the reasonably well-behaved banks prior to the crisis are now, through financial contagion, getting into trouble because other institutions behaved badly and the related systemic issues (i.e. excessive leverage, insufficient liquidity, derivatives, mark to market, among others things).

The question I have is this: 

Why is it a good idea to wipe out the common stockholders of a well-run bank that got into trouble because of the excessive risk taking by others and systemic flaws? How do you suppose those with risk capital around the world would view future investments in U.S. banks if that happens?

A better capitalized/less leveraged banking system needs as much equity capital from private sources as possible. Well, wiping out equity in a cavalier manner (and I think nationalizing banks across the board qualifies) just makes equity harder and more costly to raise in the future.

Inevitably, a poorly run bank will produce big losses for its common stockholders. That's a perfectly appropriate outcome. It's when a good bank is taken down by the behavior of others -- or due to any systemic meltdown -- where the line must be drawn.
(Who behaved well and who did not might not be clear-cut but it's far from impossible to judge.)

If we're not careful the current serious but now fixable problem will get to the point that nationalization becomes the only reasonable option. The consequences and costs of nationalization are not small and need to be considered carefully. We'd benefit greatly at this time from fewer provocative statements regarding nationalization. Such a serious fork in the road deserves thoughtful commentary. Expertise, visibility, and influence should be put to productive use. Let's at least try to make sure the emergency doesn't become so great that nationalization becomes inevitable. This, to me, would be a terrible and unnecessary outcome. The experts -- some who are frequently visible on popular media outlets -- will have been "right" about the need to nationalize. The fact it could have been avoided -- beyond the possible lessons learned -- will then be irrelevant.

Statements like the "system is close to being insolvent" and calls to nationalize banks are feeding the fire that's already been set. The window has not closed but some seem convinced it has. Many banks are not anywhere near insolvent today on an economic basis. Some are under terrific stress, no doubt, yet still have enough earning power to repair their balance sheets over time. So it's far from hopeless. Bank balance sheets shouldn't necessarily look great during a financial crisis. Some do have balance sheets that appear, at least for now, insolvent on an accounting basis and maybe even on an economic basis. For these banks the picture is not a good one. Intervention is inevitable. Up to a point, regulatory forbearance can be wise for those banks that have, on a normalized basis, sufficiently good assets and earnings capacity; it can be wise when economic activity is temporarily reduced and no one's in the mood to buy assets. During a crisis market prices may not reflect underlying economic value. This could make bank balance sheets appear temporarily weaker than they really are depending on the accounting rules in place.

What is your car worth if you have to sell it in the next fifteen minutes? How about if you have a year to sell it? Two materially different prices. Forced selling can lead to a temporary mispricing of assets compared to underlying value.

Shore up the banks through capital raising (where possible, at fair equity prices not temporary market meltdown prices) then monitor behavior closely. Deal with the failing institutions decisively. Otherwise, allow the banks to earn their way back to full strength as long as they have the capacity to do so. Plenty of banks are capable of this if given some time.

Early intervention is often the right call when it comes to stabilizing a financial system. Yet patience and regulatory forbearance can also make sense for those banks that are economically sound but temporarily under pressure. The right call varies depending on the institution and the circumstances.

Private capital needs to believe that equity won't be wiped out in an arbitrary manner. Otherwise, equity capital will become too costly and too difficult to come by.

In any case, decisive action is needed sooner than later.

Nationalizing the banks won't do the trick.

Economic dynamism will be lost.

To at least reduce the likelihood and scale of a future financial crisis, much more capital and liquidity should be required.

There'll surely be another financial crisis, but we can still work to delay the inevitable and mitigate the effects.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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