Friday, February 27, 2009

Denial And Soft Nationalization

Lot of market observers who follow the banks are still in denial. Take for example Dick Bove, a guy who has been consistently wrong on the financials for the last 2 years. He tossed in his usual 2 cents this morning. Despite Citigroup plunging on the announcement of government plans to swap its preferred stock for common equity.

Mr. Bove states the following: "I absolutely believe they are a buy". He goes on to state Citi is cash-flow positive, had a significant amount cash on hand and has businesses with very strong franchises. "I think on that basis one should want to own the stock". I don't even know where to begin with these statements. His best missive is the following gem: "that markets were obsessed with the meaningless capital levels and weren't looking at
fundamentals". What Mr. Bove fails to understand is that Citigroup is plunging because like Bear Stearns, Lehman, Wamu, & Wachovia there is a general lack of confidence in the physical entity, coupled with frozen credit markets, continued denial over mark to market pricing of securities, and most importantly the investment community has totally lost all confidence in managements ability to lead. Also...The fundamentals do suck. I am beginning to believe that Mr. Bove comes from a long line of deniers, his great grandfather must have had a strong buy on the White Star Liner in the weeks following the Titanics sinking.

What the government is doing is effectively and philosophically nationalizing the system without intently telling you so. Lot of analysts deem this a scary proposition, they couldn't be furthest from the truth, the market currently has regained all of its losses as I speak. The market is in the process of filtering out all of the static that is currently in the system. It needed a resolution to the Citigroup mess, it partially got it. Now we know, Citigroup will not file for bankruptcy as the government is its the biggest backer. So as more and more of these type of transactions are transferred to other sick banks, the market will come to grips with it. BOFA & Wells are next, no matter what the analysts say.

What the government is doing is the quickest, but not the lowest cost solution to the current problem. The country cant afford what happened to Lehman to happen to BOFA, Citi, and Wells. The next step is to effectively extract these toxic securities from the balance sheets of these institutions and place them in a RTC (Resolution Trust Company), similar to what happened with the Savings & Loan.

Listen...The whole planet is in the midst of a massive de-leveraging campaign that has seriously dented confidence not only in the US, but the global financial system, the only way to restore confidence is to have a concrete plan. The US leads the world, as Europe and Britain are already on their way to fix their issues. The global economy is waiting for the U.S. to step up. They did today.

This is step 1 of the plan - Conversion of TARP Preferred to Common Equity.
Although its mighty dilutive, the banks and shareholders have no choice. We will have a few days of heavy selling (Financials) as investors will get ahead of any future conversion, but there will be a point where these institutions are buys.

There is probably a dozen more steps to be taken, but remember it took 30 years to create this credit bubble, it will take the better half of a decade to resolve it, but confidence needs to be restored.

There was two things the government could have done to go about addressing the banking crisis:

1- Closed Bank Solution: Close bad banks, wipe out equity shareholders as well as debt holders, extract bad assets transfer them to RTC, and then sell off the good parts of the bank back to the public markets as soon as possible. This is what the government did partially to Wamu and IndyMac. These were successful, but the current scale of losses make this politically (Lobbyists/PACS) unfeasible, although its the most cost effective.

2- Open Bank Assistance: Inject capital into institutions, guarantee bank liabilities, access to greater liquidity, and TARP. This is what I call "Soft Nationalization"
This has been what they have been doing to the likes of Citigroup today and Wachovia previously....This is what they will continue to do for the future, but they also need to incorporate most importantly the extraction of bad assets into RTC. After they accomplish this, they can start to recapitalize the good banks with private equity and re float them to the public.

The market is trying hard to make up lost ground, but there are heavy losses in the financials that are being offset by gains in Tech and some Energy.

Keeping the Faith.

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