Too Big to Fail, Or Too Dumb to Survive?

I am sick and tired of hearing my national government tell me the reason they have to take OUR money to pay bonuses for AIG, Goldman (GS), Morgan Stanley (MS), et al is that these firms are “too big to fail.” Horsefeathers. I say, if they’re too stupid to survive on their own, let’em fail.

Do our regulators / Congress / other assorted politicians really believe that without Citi (C) and B OF A (BAC), Americans will start paying their bills with money orders and wire transfers from Western Union? No way. Americans are far brighter than their elected representatives represent. If Citi goes away, we’ll just bank with a different, better-capitalized, more customer-focused bank that doesn’t spend its energy trading six-sigma, seventh-tranche bits of derivatives of derivatives. You know, banks that take in money from depositors and lend it responsibly to borrowers.

Way back in October, when “They’re too big to allow them to fail,” was first being intoned by the now-at-an-undisclosed-location Hank Paulson, I went on record as opposing the bailout. I said I’d prefer “to see Americans benefit by receiving equity ownership stakes from the miscreant executives, traders and firms who created this mess. If actions have no consequences, then the venal will commit them again, laughing at our good intentions all the way to the Hamptons... I’d rather see $700 billion go to injured bystanders on Main Street than to those who now hold us hostage by fanning the false flames that they’re all simply too big to fail, claiming Main Street will suffer a terrible tidal wave if Wall Street were to see a tiny ripple and lose a single bonus.”

I’ve been in the financial business 37 years. Now I don’t know banking as well as I know the brokerage business, so I sat down with a bottle of 37-year-old (only 28 of it in the cask; I just can’t bring myself to empty this bottle) Ben Nevis Scotch whiskey to research every time a Wall Street firm claimed it was “too big to fail.” In the past, we allowed every one of them to fail or made some other brokerage and its shareholders – not the unaffiliated-with-Wall-Street American citizen – take on their risks and possible rewards. These are just a few of the firms that disappeared into bankruptcy or were shotgun-married into other firms by the Fed or the Treasury:

E. F. Hutton — A fine old firm founded in 1904 that by 1985 had pled guilty to 2,000 counts of mail wire fraud. Bought for a song by Shearson.

First Boston — The world’s biggest M&A player got greedy, over-reached and, in 1990, in violation of Glass Steagall, the Federal Reserve decided the integrity of the financial system was at stake so to avoid bankruptcy shotgun-married it to Credit Suisse (CS) of Switzerland.

Kidder Peabody — Bought by GE, Kidder got into insider-trading trouble (including false accusations against Richard Wigton, a courtly gentleman who helped train me in 1972, and was led from his office in handcuffs as a stunt by an ambitious prosecutor named Rudy Giuliani. Wigton was shortly cleared of all false charges). Was dumped by GE over to Paine Webber (PW).

Paine Webber — then itself over-reached, got in trouble, and was bought for a song by UBS of Switzerland.

White Weld — got in trouble, was bought for a song by Merrill Lynch, which got into big mortgage-backed securities trouble, and was bought for a song by B of A.

Bache — bought cheap by Prudential (PRU).

Drexel Burnham Lambert — founded in the depths of the Depression, insider-trading felons Michael Milken, Ivan Boesky & Dennis Levine later dragged the firm into bankruptcy. A massive failure, no bailout was offered -- probably because the Treasury Secretary, Nicholas Brady, had been chairman of competitor Dillon, Read when Drexel bested them on a hostile takeover deal.

Salomon Bros — bought by Travelers in 1998, which was bought by Citicorp.

Smith Barney — bought by Primerica, which was bought by Commercial Credit, which bought a piece of Travelers, which was bought by Citicorp.

Hornblower & Weeks, Hemphill, Noyes -- got into trouble for writing “exaggerated and misleading” research. Forced into Shearson. I just like saying Hornblower & Weeks, Hemphill, Noyes.

Shearson — bought CBWL-Hayden, Stone; E.F. Hutton; Hornblower; Hammill & Co, and others on the way to being itself bought by American Express (AXP).

Dean Witter — merged with Reynolds & Co in what was then the largest securities industry merger in history. Acquired by Sears (SHLD), then merged into Morgan Stanley.

Bear Stearns & Lehman Bros. -- you know the story...

Two things emerge from this trip down Memory Lane. First, almost every time one of these firms did something greedy or stupid, there was a hue and cry from Wall Street that civilization as we know it would end if we allowed one Wall Street firm to fail. We allowed it. Life went on. One fell; a new one arose. It’s called capitalism.

Second, situational ethics is a crock. If we decide it’s OK to cheat the American public because too much money is at stake not to, we’ve lost way more than money. If we don’t have the moral fiber to hold the rapacious responsible for their actions, we’ve lost something considerably more important than a few hundred billion dollars.

Oh, yes. How to play it. I figure AIG is a Dead Man Walking and Citi and B OF A aren’t far behind. I wouldn’t buy Goldman or Morgan for the same reason some people don’t buy tobacco companies or gambling companies. (They sell snake oil and it’s addictive and bad for your -- in this case, financial -- health.) But I am seeking and finding lots of smaller regional banks and brokers that I believe will gain market share. And I’m buying the preferred shares of these firms because they have been unfairly knocked down in concert with the preferreds of C, BAC and the other losers. It’s overdone. I’m getting 12%-16% yields on preferreds that, if I’m correct and the company survives to redeem them, will redeem at par, what I paid 50 cents on the dollar for.

Five banks I think will gain market share are Wells Fargo (WFC), US Bancorp (USB), Key Corp (KEY), SVB Financial (SVB), and PNC Financial (PNC). Each has preferreds selling well below redemption value. I’ve been buying them when they get to 50% or less of redemption price. Among their offerings are WFC pfds WFC-J, FWF, JWF, WSF and WCO; US pfds USB-E, USB-G, and USB-J; Key pfds KEY-A, KEY-B, KEY-D, KEY-E, and KEY-F; SIVB pfd SIVBO; and PNC pfds PNC-C, PNC-D, PNC-L, PNU and PNH.

DISCLOSURE: Long at least one preferred series of each of the above banks. Looking for more at the right price.

Comments

[elcopone:]

Agreed, the "too large to fail" argument is getting old. Th cost of inaction must be rivaling the cost of action at this point. And the sad thing is for all the bailout money already spent, no one even knows if it even worked. Had the government not bought Wall Streets egotistical "too large to fail" argument, they would be in Chapter 11 with a clearly defined plan to keep operating and emerge. As it is, you now have increased consumer distrust due to the lack transparency around the bailouts.

What does it say about our government when AIG execs are more scared of lawyers opinions and their own executive's potential lawsuits than they are about the governments wrath?

The biggest problem with the Wall Street bailout is that it's being run by Wall Street.

Mar 18 08:28 AM

[Speedspirit:]

By your estimates the smaller will survive and grow but the underhanded forces at work are hoping to take over your smaller banks by destroying them first. This seems to risky here at the point of indecision. Maybe a nibble is justified but things can still go either way for the smaller banks. In a world of proper justice you will hopefully be correct but if policy keeps on course BEWARE

Mar 18 08:28 AM

[Tradememe:]

All we have to do is to compare the situation of the world's financial system before and after the bankruptcy of Lehman. And we will get an idea of the risks that these mammoth financial institutions pose to the economy. Are we ready to take the gamble and let them fail ? There is no going back once it's done.

Mar 18 08:39 AM

[Captain Friday:]

Can't stop thinking about the scene in the movie '48 Hours' when Eddie Murphy is frisking the rednecks in Torchy's bar. He pulls a wad of cash from one redneck's pocket and asks "Where'd you get this?", receiving the answer "Tax Refund". Murphy retorts "Bulls***! You're too stupid to have a job".

Mar 18 09:14 AM

[overopinion...:]

Whether you like it or not, the government invested in these "too big to fail" companies. Get over it.
At this point the question becomes, how to make the most of that money. Chasing the best minds from these companies out of them and into WFC, PNC, etc... doesn't help. And they will run there. There are plenty of brilliant people still in AIG, MS, GS, C, BAC and so forth who are staying because they are motivated by the game, the chance to prove themselves, but if persecuted (aka senator on a radio show talking about how the AIG execs are better off dead and should kill themselves), they will leave, and be happily accepted elsewhere.
AND THEN?
All the money in the world can't turn these companies around, and it will be a massive loss for the taxpayer.
If you can excuse making me pay taxes to help my neighbor's mortgage for the greater good of the community, why are you squabbling over contractually obligated payouts at companies that have already been deemed too big to fail and invested in.

I am not arguing whether or not the investment should be made, simply that it has, and now we have to deal with the investment made, not the investment that should have been made.

Mar 18 09:27 AM

[User 373658:]

Things are a mess and someone is not doing their home work before passing out our tax dollars. I listen to Congress grilling CEO's and can't help but wonder; "Wouldn't it be just as appropriate for Congress to sit below and answer some questions under Oath?"

Mar 18 10:41 AM

[User 369530:]

Joseph:

Disclaimer - Off Topic and Scouts Honor I have no connection to Joe.

Thanks for the USB preferreds suggestion from just 2 weeks back. I had been thinking about these but your article nudged me into action and now I'm up 30%+ on it and have already received a nice divy check to boot.

I looked back at some of your older stuff and click the button to add you to my watchlist.

On topic - I used to think Ken Lewis was a smart fantastic CEO, and wondered why in the heck he bought Countrywide & Merrill but figured that he HAS to know better than I about these things. Well guess what??


Thanks again, Mark

Mar 18 02:48 PM

[Joseph L. S...:]

My pleasure, Sir! Our clients are feeling pretty good about all those preferreds, too. If, in their haste to sell anything related to the POORLY-run firms, someone is going to sell shares in the WELL-run ones, too, we'll happily pick up those $100 bills blowing down the street...


On Mar 18 02:48 PM User 369530 wrote:

>
> Joseph:
>
> Disclaimer - Off Topic and Scouts Honor I have no connection to Joe.
>
>
> Thanks for the USB preferreds suggestion from just 2 weeks back.
> I had been thinking about these but your article nudged me into action
> and now I'm up 30%+ on it and have already received a nice divy check
> to boot.
>
> I looked back at some of your older stuff and click the button to
> add you to my watchlist.
>
> On topic - I used to think Ken Lewis was a smart fantastic CEO, and
> wondered why in the heck he bought Countrywide & Merrill but
> figured that he HAS to know better than I about these things.
> Well guess what??
>
>
> Thanks again, Mark
>

Mar 18 06:09 PM

[Mad Hedge F...:]

I have a question, Mr. Market. If General Electric (GE) got down to $5, Bank of America (BAC) $2, and Citigroup (C) to $1, where were the share buybacks? Are these companies too broke to buy their own shares, or do they think a few bucks over zero is too much to pay? I’m not sure I like either answer, or even my own question.

Mar 18 08:56 PM

[maryanne:]

Above list of preferred is not complete. Go to quantumonline.com to find them all. I have BWF (Wells Fargo) and USB-L. Nice history of all those brokerages.

Mar 23 07:41 PM