Yesterday we saw a typical Buffett move as he surprised everyone by taking a $5B investment into Bank of America (BAC). Everyone is talking about it and praising how good this is for the company, I guess it kind of is, but there are others, like me, who are more worried now than before Buffett made the investment. I do not own BAC and I am not short BAC or any financial firm right now so I have no self serving purpose for this.
What concerned me is the fact that the figure was $5B just like the Goldman deal. This seems to be a figure Buffett is comfortable risking in times of duress. Buffett has billions on hand, but only $5B that could yield him 6%? Something isn’t right. Now, I considered the pre-Buffett chatter about BAC to be the typical rumor mill stuff, illiquid, cut off from the markets, huge liabilities that haven’t been realized and the like, but nothing real or substantially true. However, I admit the massive selling of pieces of their business did strike me as if they were concerned about things, but it did not strike me that they were going out of business, it was merely troubling. However, now with Buffett adding in his now typical $5B ‘petty risk cash’ into the firm it does make me concerned about BAC.
Clearly the firm needed the cash as it was presented to them and accepted in, what, 12 hours. You do not take $5B paying out 6% when we are in a zero interest rate environment and can issue paper cheaper without raising any suspicions. Frankly, taking a middle of the night cash infusion from Buffett is strikingly similar to 2008 for my taste. BAC got hosed on this deal, as many others have already said, and they are paying way too much for this cash. A case can be made that BAC paid the premium for the Buffett 'seal of approval’ but that seal did not work for Goldman (GS) in 2008.
If one followed Buffett in 2008 on the Goldman deal they lost out pretty badly. After the cash infusion was made, Goldman dropped to $48/share, about $70/share below Buffett's investment, and the average investor would have probably sold at a loss given the events of 2008. If they were smart they would have doubled up, but come on, it was 2008. Regardless, Buffett was too early and could have done much better if he waited, but more to the point, what kind of due diligence did he do back then? I am thinking more than he did with BAC, but no one knows for sure. What I do know is the government had to follow up on Buffett’s investment to the tune of $700B as they had to save the whole system. The government bailed out Buffet in the Goldman deal, basically.
What is different this time is the fact that countries are going broke now, not just banks, and there is risk everywhere. With BAC not only do you have sovereign risk, but you have derivatives risk and a whole bunch of mortgage issues from put backs to just bad loans altogether. I believe this time is very different because it is sovereign risk and we have had this issue before… in the 1930’s. In the Depression Europe had defaults and many countries devalued their currency which hurt the U.S. as we, at that time, were a net exporter of goods. The European issue deepened our depression and the same thing will happen this time around, unfortunately. Not only may BAC hold European debt on its books, but they might have CDS exposure as well, not that we would know about that, thanks Frankendodd. In any event BAC is one hot mess and the sad thing is that BAC will not drop from $110 to $48 because it is at $7 already, you do the math to see what a similar drop would look like for BAC.
I do not think BAC is finished, it might be, but I doubt it. I do believe it will be stuck in the single digits for a very long time. For crying out loud, they bought Countrywide, just a reminder.