The 2008 unraveling of the global ponzi was ignited by the failure of Lehman. That identifying moment has crystallized perception that we are one Lehman away from financial Armageddon. When Lehman went, it started a chain reaction that led to massive government intervention across the world. Sensationalistic books and movies highlighted the potential danger of implosion once Lehman gave way, and every large negative movement in the financials now brings on the hunt for the "next" Lehman.
Lehman Flashback Syndrome
Because Lehman was tagged as the linchpin for failure in 2008, and that avalanche eventually led to the hated TARP, we now collectively have Lehman Flashback Syndrome (LFS). LFS is an emotional response triggered by a need to discover the root cause of any anomalies in the financial fabric of the world's largest economies. LFS reignites fear, and reminds us how fragile our monetary ecosystems can be.
Bank of America (NYSE:BAC) was being touted as the "next Lehman" just a few weeks ago. After that, it was Societe Generale (SocGen) that was "Europe's next Lehman". Who it will be today, next week, or next month; will depend on who appears to be the weakest. Once identified, the major market players can gang up on the weakling and drive their stock to insanely new prices, thus perpetuating the perception of validity.
LFS can be applied to any financial company that has the following characteristics:
- Large financial company, preferably a big bank
- Publicly listed in either the United States, Japan, or Western Europe
- Formerly a large dealer in either Credit Default Swaps or a large lender to the PIIGS
- Past reputation for mis-steps, hopefully already been bailed out once
The large financial companies can unravel the entire system, so when they can be infected with LFS, then fear and panic can be felt by all. In addition, the largest financials have greater complexity, and thus less faith in their audited financials. Doubting stability creates a loop in which it is impossible to disprove negative thoughts. Fear then runs wild as investors can imagine anything.
2011 Is Not 2008
In 2008 our financial system was on the precipice because the large financials were not prepared for how quickly the situation could unwind. They were dangerously leveraged, under-reserved, poorly scrutinized, and capital deficient. The whole global system was in turmoil and extraordinary measures were needed, and in fact delivered.
Fast forward to 2011. Leverage has been reduced meaningfully, reserves are at records, every politician, analyst, and lawyer has scoured through every speck of data for problems, and finally capital has been injected through government bailouts, equity capital raises, and asset sales. In addition, the problems that the system experienced is due to activities prior to 2008. Since 2008, banks have tightened lending standards and been reluctant to take new risk. Today's perception of preparedness is the same as in 2008, but the facts are 180-degrees different. The system might need to recalibrate, but a major overall is not going to happen.
Lets look at five major systemic financials:
Bank of America (BAC)
- Price: $6.97
- Now tangible common equity $128B from $62B 2008
- After writing off $95B in loan losses since 2008
- Still have loss reserves of $37B.
- Price: $26.77
- Now tangible common equity $142B from $30B 2008
- After writing off $90B in loan losses since 2008
- Still have loss reserves of $34B.
Goldman Sachs (NYSE:GS)
- Price: $111.76
- Now tangible common equity $64B from $37B 2008.
- Price: $34.35
- Now tangible common equity $127B from $94B 2008
- After writing off $74B in loan losses since 2008
- Still have loss reserves of $29B
Wells Fargo (NYSE:WFC)
- Price: $23.36
- Now tangible common equity $92B from $65B in 2008
- After writing off $56B in loan losses since 2008
- Still have loss reserves of $21B.
As you can see above, the effort has been diligent. Our top 4 banks have taken charge-offs in excess of $300B, raised tangible common equity over $200B, and still have total loan loss reserves of $120B. While this is a small sampling, the same degree of diligence has been happening across the globe. From AIG's (NYSE:AIG) shedding of major units, re-capitalizing, and winding down their CDS business; to General Electric's (NYSE:GE) controlled balance sheet shrink, large financial institutions have indeed focused on the issues.
Today there is ample evidence of preparation, and those looking for full implosion will be disappointed. The fear of another Lehman is nothing but a flashback, driven by emotion rather than by facts. While we don't attempt to call the absolute bottom, we do believe that this market has driven prices of top-tier companies to opportunistic levels. It is time to scale-down buy this market, and understand that Lehman was the last "Lehman".