'Nationalize Insolvent Banks': Buffett Didn't Get Roubini's Memo

Did you get a chance to read Nouriel Roubini’s February 12 column in Forbes? I don’t know if he gets to write his own headlines, but whoever did write it got to the nugget of the message he’s been spreading ever since:

“Nationalize Insolvent Banks”

Pithy! Nouriel Roubini seems to be on television every other night lately, so you’ve probably heard his argument already as to why the government needs to take over the country’s big banks, and the sooner the better. If you missed it, though, it boils down to two words: “toxic assets.” FAS 157 or not, the banks still haven’t marked down their bad assets to their true value, he believes. And once they do, the balance sheets of most banks will essentially be wiped out. Or, as he put it in his Forbes column last month:

A true valuation of the [large banks’] bad assets--without a huge taxpayer bailout of the shareholders and unsecured creditors of banks--implies that banks are bankrupt and should be taken over by the government.

Thus, all the schemes that have so far been proposed to deal with the toxic assets of the banks may be a big fudge--one that either does not work or works only if the government bails out shareholders and unsecured creditors of the banks.

Better to shoot ‘em now, and put them out of their misery. Once Roubini started pushing for bank nationalization, of course, the drumbeat only got louder. Even people like Lindsey Graham and Alan Greenspan allow that it might be a sensible idea.

I mention all this because I was struck by what Warren Buffett—who knows a thing or two about the banking business, don’t forget--had to say, during his interview with CNBC this week, about the very same bad assets that has Roubini so alarmed. Buffett seems to be watching an entirely different movie:

The interesting thing is that the toxic assets, if they're priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they've got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own. The problems of the banks are overwhelmingly not toxic assets. . .

Dizzy yet? Roubini believes banks’ toxic assets haven’t been written down by enough, while Buffett says they’ve been written down by too much. And while Roubini says the U.S. banking industry is “essentially insolvent.” Buffett thinks the industry is on the verge of unprecedented profitability. Here’s more from the CNBC interview:

The spreads have never been wider. This is a great time to be in banking, you know, if you just get past the past and they are getting past the past. I mean, right now every time a loan is made to somebody to buy a house--and we're making, you know, making millions of loans--four and a half million houses will change hands this year out of a total stock of less than 80 million. So those people are making good mortgages. You want those assets on your books and you get a great spread in putting them on now. So it's a great time to be in banking, but you do have to get past this past. But the toxic assets, in my view, you know, if they've been written down to market, I'd rather buy those assets from the bank than any other assets they've got.

“This is a great time to be in banking.” Now there’s a sentence I’ll wager you haven’t read too often lately. On Wells Fargo in particular, which Roubini has described as a “zombie,” Buffett is rhapsodic:

Now, if I looked at the performance of Wells Fargo we'll say, I see that, you know, in a couple years--and management doesn't have anything to do with what I'm saying here. I--these are not from them. But I would expect $40 billion a year pre-provision income. And under normal conditions I would expect maybe $10 to $12 billion a year of losses. I mean, you lose money in banking, you just try not to lose too much. So, you know, you get to very interesting figures. I mean, the spreads are enormous on what they're doing. They're getting the money at bargain rates. So I--if there were no quote on Wells Fargo and I just owned it like I own my farm, I would look at the way the business is developing, and I would say, you know, it's--`These are a couple of tough years for losses in the banking business, but you expect a couple tough years every now and then.' And that the earning power is never--is going to be greater by far than it's ever been when you get all through with it. . . .

One of these two guys is going to turn out to be really, really wrong. You’ll have your own view as to which one makes more sense. To me, it’s not even close: Buffett does. First off, a lot of the work we’ve done around here confirms his view of the marks banks have taken on their iffy assets. There’s often a huge gap between the “fair value” marks banks have put on those assets and their corresponding cash flow marks—with the fair value marks typically being much lower.

And don’t forget that, by his own admission, Roubini doesn’t know what he’s talking about when it comes to individual banks. He only looks at the macro data, without getting into details of specific institutions. Buffett does know—he’s Wells Fargo’s biggest shareholder, for crying out loud!—which means he has a lot more detailed knowledge about what’s really going on in the business. Oh, and Buffett’s been through a few more cycles.

In any event, these two gurus don’t just have mildly diverging opinions about the outlook for the banking business. Their views are at 180-degree odds with each other. One says the industry is about to go tapioca, the other says it’s about to enjoy huge profitability.

Whom do you trust? I know I’m ready to vote.

Comments

[JudeJin:]

maybe you don't understand them.

there's a common thread behind what they just said. the marked down assets will appreciate in the future but the loss so far wipe out the equities and they're making good profits on new business.

both of them are right. buffett is betting on a free ride on the taxpayers. buffett's moral should be questioned!
remember, buffett's amassed fortune was never taxed! yet taxpayers are bailing out his wells fargo!!

Mar 12 02:48 AM

[Fighting Yoda:]

Buffet has lost it, he is simply speaking his book. US banks are insolvent, as per Roubini macro picture.

All the leveraged debt - right now we have only gone through subprime and residential. We still have to go through the commercial mortgages, corporate bonds, consumer loans - auto, credit cards, not to forget home equity loans.

We have the trifecta of tsunami, earthquake, and nuke all combined in one.

Nationalization in itself will not solve anything, it would simply add burden on the tax payer – as we have seen with AIG, Fannie/Freddie.

As is being suggested all bank asset holders equity, preferred, bond holders etc have to take major hair cut. This is the proposed solution in the auto industry. Banking industry meanwhile is getting a free ride at the expense of tax payers. Hopefully things will change.

Mar 12 03:03 AM

[Dagmountain:]

Are you crazy? What about Merrideth Whittney? Do you think She knows what she's talking about? She says these banks are marking these assets at peak to trough loss rates on housing of about 22 percent. S& P is estimating 30 to 35% drops peak to trough. Whittney says, "That will take us back to two thousand rates when home ownership was actually higher. That's mathematically impossible". How does forty percent sound to you? There is a huge shadow inventory and huge slack in the demand for housing. In 2008 home ownership rates were 68 percent. Before the bubble it was 64 percent. The supply and demand curve is brutal. Your love of the banking oligarchy is sickening. It's articles like this one that are responsible for some of the most incredible wealth destruction we've seen so far. Stop drinking the kool-aid and do your job as a journalist.

Mar 12 03:16 AM

[mgv11:]

A breath of fresh air, the damage is done to the banks, recovery is now the issue. So let me ask, why are we so gung ho to seperate these toxic assets from the banks to "the smart investors"? Because they have more value than ever before! I almost want to call it a conspiracy allowing the wealthy to get wealthier.

But back to the recovery of the banking system, what turns it around? the new investors? the new bankers? the ones who just bought the toxic assets? Seems inconsistent to me... it is simply a transfer of future wealth to the current rich from the common equity owners who were recently wiped out. By liquidating all the banks in trouble to those buyers who didn't get wiped out... and they will be using the toxic assets to make their money.... I'm sorry my money, Mr. Common Equity holder.

To Merideth Whitneys current point... credit card debt, really what she is saying is SELL it now before the disaster hits. I'm thinking the toxic asset investors don't want it yet. The time to sell it was 2 to 3 years ago.

The banks have dug themselves a hole, time will heal many of them, not all, we're seeing failures every friday. Right now, I'd rather see the common equity owners ( yes that means gov't too) who have taken a beating have a shot at riding the wave of the future as they recover vs transfering these assets to private investors who quite honestly probably don't need it... and does anyone know for sure they can help the economy? I'm thinking they've put on their protective clothing and waiting for the disaster to bottom, then they'll step in and help. I'll bet the current banks are more motivated than these investors. The ironic part is when stepping in at the botton you look like the saviour but in reality all they are is opportunist with better timing.

Just a thought

Mar 12 04:01 AM

[W. L. Ingram:]

The key terms in Buffet's argument is "...assuming they have a market-to-market value." and "...IF they've been written down to market value..." (emphasis mine)

What is the market value? When "...a total stock of about 80 million..." homes are going under, "...four and a half million 'good' loans" somehow defines market value. Not a convincing argument to me.

We can discuss macro economics of banking all you want. It's fun, really.

But since you insist on microeconomics of banking, let's look at the picture. Banks assets are their loans. Banks liabilities are the money depositors place in the banks. Show me major US bank, any bank, where the P&L balance. I'm a Missouri boy. I'll wait. Just show me.

When assets go belly up--and banks are NOT in the real estate business--liabilities become more pressing.

Maybe the best solution is for everyone to make a run on the banks and pull all our money out of them. Liabilities solved. Banks P&Ls balance and happy days are here again. (Just kidding--kind of)

From a macro perspective major banks are bankrupt. From a micro perspective major banks are bankrupt.

And taxpayers should bail them out?

Okay, but first we line up all the banks loan committees and shoot them.

Mar 12 04:08 AM

[KIT:]

Buffett has put his capital to work as loans not as stock purchases. This suggests he is in hold mode gathering more cash. The tell for me is promoting bank stock but not buying it. Had he sold half JNJ and used the money to buy AXP or WFC it would show a 20% was dropped if favor of a higher bank return

Mar 12 04:23 AM

[User 305589:]

thanks tom, for putting these two views up for comparison. I am 100% here with Buffet. But as one can see just from the three responents above, gloom and doom predictions and utter fear have been burnt very very deep into the minds of people. I doubt that anyone of the three ahs ever really looked closer at these banks, say, at wells. They all rely obasically on the repeated bearish calls from Roubini and Whitney. Which, essentially, is like relying on a rising chart to predict another rise down the road. Never mind that analysts - even smart ones like whitney, are usually behind the curve when it comes to grasping turning points. ivory tower academics like roubini (and bernanke, for that matter) even more so.

of course that now deeply entrenched negative attitude can have a very real effect on the economy. If everyone expects gloom and doom, it is almost certain to happen, simply because of the people's actions based on their fears.
yet, i am with buffet on that
btw, buffet also called for a distinction to use mark-to-market for disclosure and information - but not to rely on it for regulation. It#s sad that cnbc omitted this, but the hard truth is that giovernment regulation demanding ever more equity for banks because of mark-to-market losses is not helping, but killing the banks. as usual, the more gióvernment starts to muddle with matters they have zero expertise in, the worse a situation gets.

to me - and to the markets, obviously, this is the real worry and big wildcard: will sound banks like wells be able to get out of their troubles and to demonstrate that before the government succeeds in killing them with its, ehm, 'help' ?

Mar 12 04:36 AM

[User 305589:]

never mind that buffet said that axp was a great bargain around $10 but that due to the stake berkshire already holds he is not allowed to buy more.
and he has bought wells sommon - even for his personal account.

but why bother with facts, if they stand in the way of your opinion?
go figure.


On Mar 12 04:23 AM KIT wrote:

> Buffett has put his capital to work as loans not as stock purchases.
> This suggests he is in hold mode gathering more cash. The tell for
> me is promoting bank stock but not buying it. Had he sold half JNJ
> and used the money to buy AXP or WFC it would show a 20% was dropped
> if favor of a higher bank return

Mar 12 04:41 AM

[User 305589:]

regarding amrket value: if a performaing asset, like a mortgage loan portfolio that delivers a cash flow stream of, say, 100 million a year, gets a 'market price' (i.e. a distressed quote in an illiquid, dysfunctional market with very few byeusr, because noone has the cash RIGHT NOW)) of 150-250 million - which is rather a common quote, not an exception - where do you put a fair value? in 2-3 years you will have the entire 'market value' be paid off by cash flows and then you still hold the asset, which, even with catastrophic default projections, will continue to generate cash flows and has recovery value. yet, you require the bank to put up more equity FOR THIS ASSET! This is, wher it gets absolutely ridiculous! The government demands that banks raise equity at prohibitve prices or sell these assets. Brilliant move! Both destroys value - or rather shuffles it into the hands of those who can buy the stuff - mostly private hedge funds. and then, since the banks had to sell the stuff or can't raise the equity then the goovernment comes injecting billions of taxpayer money. But essentially, these billions go in there because of government ignorance in the first place - they were in most cases not needed to begin with were it not for senseless regulation that produces unintended consequences. A lot of taxpayer money could be saved wihtout making the economy or the banking system more risky. But instead, the billions flow indirectly into the pockets of hedge funds and vultures. Brilliant, really.

On Mar 12 04:08 AM W. L. Ingram wrote:

> The key terms in Buffet's argument is "...assuming they have a market-to-market
> value." and "...IF they've been written down to market value..."
> (emphasis mine)
>
> What is the market value? When "...a total stock of about 80 million..."
> homes are going under, "...four and a half million 'good' loans"
> somehow defines market value. Not a convincing argument to me. <br/>
>
> We can discuss macro economics of banking all you want. It's fun,
> really.
>
> But since you insist on microeconomics of banking, let's look at
> the picture. Banks assets are their loans. Banks liabilities are
> the money depositors place in the banks. Show me major US bank, any
> bank, where the P&amp;L balance. I'm a Missouri boy. I'll wait. Just
> show me.
>
> When assets go belly up--and banks are NOT in the real estate business--liabilities
> become more pressing.
>
> Maybe the best solution is for everyone to make a run on the banks
> and pull all our money out of them. Liabilities solved. Banks P&amp;Ls
> balance and happy days are here again. (Just kidding--kind of)<br/>
>
> From a macro perspective major banks are bankrupt. From a micro perspective
> major banks are bankrupt.
>
> And taxpayers should bail them out?
>
> Okay, but first we line up all the banks loan committees and shoot
> them.

Mar 12 04:53 AM

[ArkansasAngie:]

How many bank assets do you think have been marked to market? All of them? Some of them?

I got the foreclosure list from my little ole Arkansas bank and I can assure you they haven't. On a rent equivalency basis, I can't buy'em, rent'em and make money at their current prices. And no ... they aren't interested in negotiating. Why should they. They know that Uncle FEDury is going to buy'em from them. They don't want my business.

Yes ... the price of these assets probably will over shoot their fair market value on the downside. But ... riding those assets backup will be a long, slow slog.

Banking is a profitable business if bankers can just stick with the script -- slow and steady. Stripping out the profitable banking business from the horse manure that today's troubled banks "invested" (speculated) in is fairly straight forward.

Excepting ... who pays for the divorce settlement?

Well ... According to the <A href="www.kansascity.com/bus...">KC FED, bank's bondholders should probably start thinking in terms of a 20% write off.

Mar 12 08:21 AM

[ArkansasAngie:]

Obviously I'll have to learn how to create a link

www.kansascity.com/bus...

Mar 12 08:22 AM

[raytayzmd:]

..."Roubini doesn’t know what he’s talking about when it comes to individual banks"?...such an understatement...Roubi... is an economist and, as such, his skills are limited primarily to looking things up in the library.

Mar 12 10:43 AM

[User 366653:]

Exactly the point I've been arguing with my friends and clients - All the proponents of nationalization or bankruptcy of the major banks are either academics (like Roubini and Krugman) or politicians, like Shelby and Dodd. Neither group has any clue about the real world - anyone who thinks the government can run a business efficiently needs to provide ONE EXAMPLE of a government agency running a business. They can't, because there isn't one.

Another problem - the proponents of nationalization/bankru... never explain WHY THEY BELEIVE that the toxic assets will perform better under government supervision. What happens? The bad mortgages just mysteriously correct themselves? What makes anyone believe that government management of CITI, for example, is any kind of solution? Simple common sense tells you the concept is irrational.


On Mar 12 10:43 AM raytayzmd wrote:

> ..."Roubini doesn’t know what he’s talking about when it comes to
> individual banks"?...such an understatement...Roubi... is an economist
> and, as such, his skills are limited primarily to looking things
> up in the library.

Mar 13 01:42 AM

[CLH:]

As the market improves Roubini will disappear. Hes a one trick pony.

Mar 13 07:56 AM

[Stone Fox C...:]

Find it very interesting that both of them are invested very long the stock market now. Its hard to take Roubini serious any more when hes 100% invested in the end of the world scenario that he cliams.

Its also becoming more and more obvious that this toxic asset plan is a bad idea. It'll be great to have a market if somebody does want to sell, but any bank selling now has to be despearate. Its hard to phathom a scenario when private equity sharks would come close to overpaying.

Mar 16 07:02 PM