Whenever I see irrationality in the markets, when people are either panicking in the streets or maniacally counting their profits before they exist, I like to take the opposite bet.
In October of 2007, when Bank of America was selling for $51 per share or so, I saw huge opportunities. The bank was obviously a big player in real estate, and, even before it acquired Countrywide and Merrill Lynch, even though it wasn’t as bad as many of its competitors, it had a lot of bad loans. More than that, however, it was selling for a ridiculously high price, considering the circumstances.
I started reading the analyst reports, however, and was dismayed. All of them predicted great earnings for BAC, and price targets in the high $60s, 70s and/or 80s. It made no sense. The credit crisis was just beginning, and it was obvious that all banks were going to suffer. So, I ignored the advice of analysts, and took the opportunity and the risk. I established a short position in BAC.
I was immediately sorry that I did. No sooner had I put my money on the line, than these crazy analysts began hyping the stock even more, and investors began acting even more irrationally in response. They immediately bid the stock up by several points. I was counting my losses, and getting ready to fold, when a miraculous thing happened. People began to wise up.
Bank of America was clearly not worth even a fraction of $53 per share, and, finally, people started to realize it. They began to ignore the analysts, and sell the shares. The stock came down to earth. After some stomach acid producing movements up, and then down, again, I closed the position, and it ended up one of the best trades I had ever made.
A year and a half later, I've stumbled across the stock again. I watched as the price dropped to $7 and then down to $5. I began to have regrets. If only I’d kept that short position open! If only I had gritted my teeth against yet more roller coaster activity! Think about how much money I would have made! But, that kind of thinking benefits no one.
I began another line of thought. The same “expert” analysts, who were once touting ridiculous $60 and $70 price targets, are now panning the company. It doesn’t have enough capital, they claim. Nonsense! It has the entire capital of the United States of America behind it. The U.S. government will not allow it to fail. But, it might go bankrupt, the entire company might be nationalized, and the share price might drop to $1 or even less, they warn. Balderdash! The Federal Reserve, including Timothy Geithner, who will now be the Treasury Secretary, have obviously promised to support Ken Lewis with whatever money he needs to absorb Merrill Lynch. If they hadn’t, he would have killed the deal.
The massive government giveaway program that has already been established in favor of Bank of America is a beginning. They are going to receive more. The government, in the form of Geithner, Bernanke, and so on, are now friends of Bank of America. These friends control trillions of dollars. With such friends, you do not fail, do not run out of capital, and your shares will never sell in the $1 range. In short, just as the so-called “analysts” were once irrational on the upside, they now irrational on the downside.
There has been a flurry of selling in Bank of America stock, partly because of the cutoff of dividend payments, and partly because a lot of herd-like short sellers have galloped in. These folks, like most other people in the market, tend to do the same thing at the same time. A careful look at the real situation shows that the heavy selling we have recently seen is not warranted. If you couple the selling with the buying of the U.S. dollar, it becomes even more insane. If Bank of America fails, and if Ken Lewis is left out in the cold with insufficient capital, or suffers the possibility of having his firm nationalized, the United States Treasury will need to fail first. Bernanke, Geithner and so on are all politicians, and they know how to reward their friends.
The money giveaways to Bank of America have just begun. There will assuredly be more. So far, the government has already promised to invest another $20 billion of taxpayer cash in Bank of America. They will guarantee $118 billion of Merrill Lynch’s bad assets. This is on top of $25 billion of largess previously handed out, and another $10 billion to Merrill Lynch. BAC is going to get a net $55 billion capital injection. The government has promised to backstop Bank of America after a maximum out of pocket liability of $10 billion on Merrill Lynch’s assets. Above that, the government pays the losses. I don’t know what deal could possibly be better than that.
Frankly speaking, if I had been Ken Lewis, I would also have bought Merrill Lynch. I wouldn’t have done it the way he did. I wouldn’t have relied on the representations of JC Flowers, for example, without doing my own due diligence. I certainly would have held out for a lower price. But, I would have bought it. Why? Outside of bad subprime, leveraged buyout and bad CDS debts, Merrill Lynch has a full commission retail brokerage house, second to none, with a lot of highly paid brokers, pulling in huge commissions. Their franchise basically prints money. The retail brokerage is a gold mine.
I cannot agree with using U.S. taxpayer money to subsidize private companies. I wouldn’t do it, and I don’t think it should be done. Merrill Lynch should have been forced into Chapter 11. Then, Bank of America could have bought its assets more cheaply. Giving away taxpayer money is, frankly, wrong. It rewards failure, creates moral hazard, subsidizes incompetence, privatizes profits and socializes losses. However, if they didn’t go for it, the failures would generate enormous CDS debts, to the detriment of folks close to the Treasury and Federal Reserve, perhaps the likes of Goldman Sachs, JP Morgan Chase, et. al. That cannot be allowed.
There is, of course, absolutely nothing we can do about it. The big banks in NYC and the U.S. Treasury/Federal Reserve all know each other, work together all the time, and act as one big “good ole boys” network. They are going to do this no matter what we think, say or attempt to do about it. The type of scare tactics used by Henry Paulson, at the time that the TARP bailout program came before Congress, is an example of just how far these people will go to help their friends. They will abuse our faith, and give away our money. But, since there is nothing we can do about it, and given that our money is being diverted into a slush fund for bankers, we should at least attempt to profit from it, to offset the inevitable losses we will suffer in our role as taxpayers.
Bank of America was adversely affected by the credit crunch, but it never operated its own business in the type of incompetent manner typified by the big brokerage houses. Prior to the Merrill Lynch acquisition, its only major error was to issue credit default insurance (CDS) on Countrywide Bank. That is what made it cheaper to buy that bank, rather than allow the huge CDS losses from being realized, upon its demise.
I objected to the way BAC used part of its initial bailout money to buy additional shares in China Construction Bank (CCB). The fact that bailout money exists is bad enough, but when banks use it outside the USA, it angers me. But, that aside, Ken Lewis did make a lot of legitimate money on previous share purchases of Chinese banks, made with corporate money. It recently sold some CCB shares to raise capital, but it still owns more. Bank of America bought its shares at a time when Chinese shares were selling much cheaper than now. By my estimate, it still has some $12 billion in unrealized profits locked up in the shares it retains, even after the fall of the Chinese stock markets.
The heavy selling pressure on BAC is an example of the herd mentality permeating Wall Street. Everyone does the same thing at the same time. There seems to be no clear or logical thought involved. Foolish investors habitually chase rising stocks, buy into strength, and sell into weakness, losing more and more money on the way. The only time they make money is in runaway bull markets, when everyone is buying, and when it is virtually impossible to lose. Yet, to make money, in more complex market situations, one must be sure to buy low and sell high.
The stock may be a good long term bet, but it is certainly an excellent short term play. Inevitably, the shorts, who managed to collapse the price by piling on, one after another, will need to cover. When they do, especially if it happens on a day when the market is going up strongly, there will be panic buying. The price will soar. Bank of America is now selling for a very low price, and, therefore, at the present time, at these prices, it is a screaming BUY!
Disclosure: Author holds a long position in BAC