Alex Trias

2009's Billion Dollar Man: David Tepper

Must know something I don't. Unlike the broader market, financials are not making new highs. Momentum seems to be turning negative on some issues - Citi being one of them. Goldman Sachs (shares of which I own) is pinned below it's 50 day simple moving average, and from a technical perspective, appears poised to probe lower (and that PE ratio of 35 or whatever doesn't make it look like any sort of value play, either). Maybe we're simply seeing the pause that refreshes, and Tepper brass thingies will be vindicated, but there looks like a meaningful possibility that they could get blown to bits.

Big Banks: The Consensus Is Cracking

breaking these puppies up would be the best thing for investors. There are some good businesses tucked away in all those folds of fat at places like Citi and Bank of America. And they don't play nicely with each other. At all. I wouldn't be surprised to see activist shareholders pushing for a break up - particularly if world governments (which are, after all, rather activist shareholders at this point) get the ball rolling. Expect enormous push back from management.

Not Buying This Rally

It's normal for bear market rallies to race up to their 200 day moving averages, which is about what we're seeing in various US, international and global stock indexes. This area often acts as resistance, and when it does, markets tend to fall. To where, who can guess? By the same token, we've seem some equities markets strike out high above their 200 day moving averages, in some cases, taking their short term buying momentum way above the long term selling momentum. This is true in many emerging markets and most notably in China. Whether broader markets will follow is anybody's guess, but at the moment, they have not and, in fact, are facing some stiff resistance indeed.

It is too soon to conclude whether equities are entering into a new bull market or simply bouncing up in the context of a very long term bear market. Why take a position one way or the other? Seems like a fine place to sell, if you asked me, but I wouldn't short anything either.

Why I'm Holding On to Citigroup Stock

A very interesting analysis of a very complex issue. I own some Citibank stock, but agree with many of the comments that it is a hugely risky investment. I doubt any one individual has enough information to understand Citibank's business, let alone the composition and quality of their assets. My only basis for owning this stock is that at current prices, the stock trades at a very low multiple of its' twenty year average earnings. The risk, as I see it, is that Citi will never earn anything close to what it has earned over the past two decades, and that it may yet go bankrupt or end up in a "virtual" bankruptcy situation like GM. I agree that Treasury would no doubt enjoy owning some upside if they are to take low quality bank assets onto their books (whether by guarantee or otherwise), but I do not share the view that Treasury so much as gives a passing thought to sharing any such upside with other holders of Citi common. Let's hope the author's predictions come true, but I wouldn't base an investment decision on such hopes alone.

How About Adjustable Principal Mortgages Instead?

You are onto something. I like this idea. Actually, you are onto something huge.

So, what are you doing to push this? Are you publishing? Sending proposals out? Whatever you are doing, you have a great idea, very simple, and expedient in terms of both moral hazard and in terms of shoring up asset quality as a means to get capital flowing again. With an idea this good, you really have to push it. If I can help you, send me an e-mail.


On Mar 08 11:32 AM User 366653 wrote:

> I still like my idea better. Here it is again.
>
> Like the author, I have sent this idea to everyone I can think of.
> Unlike the author, I have gotten no response.
>
> Here is my plan to help solve the bank crisis. It would apply to
> the nineteen largest banks, and would work as follows:
> The government would insure each bank's entire existing portfolio
> at the current value, subject to all applicable regulations and FASB
> valuation methodologies in force prior to adoption of FASB 157. New
> loans and investments would be subject to the same regulations, but
> wouldn't be insured by the government.
> As a down payment for this insurance, the bank would issue non voting
> common shares to the government representing twenty-five percent
> of the bank's common equity. For each year that the insurance remains
> in force, the bank would issue preferred stock representing an additional
> three percent of base level equity value to the government, for up
> to ten years.
> The bank would have the right to cancel the insurance at any time
> after three years.
> The advantages of this strategy are:
> Virtually no up-front costs to the taxpayer. In fact, the taxpayer
> would immediately receive tens of billions in equity.
> Public confidence in the bank(s) would be fully restored immediately.
> The fear of government interference, as a result of "nationalization",
> would disappear because the government's equity stakes would be non
> voting. Confidence in the entire financial sector would most likely
> improve dramatically and immediately.
> The value of the bank's common stock would probably appreciate immediately,
> resulting in a profit to the government/taxpayer. While this plan
> would dilute the existing common, it is very clear that the prices
> of most bank stocks reflect the risk of armageddon. Fifty percent
> dilution is not a problem if your stock has gone from 50 to 1 or
> 2 or 3. If you assume that profits could return to half of "normal"
> over the next five years, the newly diluted stock has plenty of upside
> from here.
> The value of the bank's preferred stock, trust preferreds, and debt
> would immediately increase dramatically. Credit ratings would be
> restored to legitimate investment grade. This means the bank(s) would
> now be able to raise new PUBLIC and PRIVATE capital, and would not
> need additional Government funds. In fact, the bank(s) would be able
> to use the proceeds of new preferred stock to repay TARP ahead of
> schedule.
> Furthermore, as compared to the plans already in place, and those
> being considered, the advantage of my idea is that virtually all
> the costs are POTENTIAL, and DEFERRED, rather than DEFINITE, and
> IMMEDIATE.
> Additionally, it is likely that gains in the bank's share prices
> would offset a significant portion of any losses that may accrue
> from the insured portfolio(s). Since implementation of this plan
> would certainly hasten the recovery of our national economy, the
> assests insured by the government would be more likely to improve
> in value than to decline any further. In any event, the government
> will be in a better position to absorb losses, since the TARP money
> will have been returned, and no additional TARP funds would have
> been dispursed.
> To summarize, my plan would "nationalize" the current loans of the
> banks, while leaving the banks intact, with no additional up front
> costs to the taxpayer. The "moral hazard" issue - helping the "shareholder"
> at the expense of the "taxpayer", is handled by making the taxpayer
> a shareholder. Confidence in the security of our financial system
> would be restored, and we could get on with trying to solve some
> of our other problems.
>
>
>

How About Adjustable Principal Mortgages Instead?

Thanks, Prudentinvestor. There is much more to your comment than appears on the surface. I take from it two deep questions. First, who pays for the loss? I am assuming (and this is a HUGE assumption on my part) that if the Treasury were to sell 30 year (or 20 year, or some other long time frame) put options on a Case Shiller Index, there would be no loss. My assumption is either (1) real estate prices increase over the 30 year period; (2) even if real estate prices fell over 30 years, the premiums paid to Treasury would adequately compensate for this risk, and Treasury could reinvest those premiums in sufficiently high-yeilding assets to pay for the losses on the put options once they expire. And yes, I am assuming European style options, which I did not make explicit in my article. So the short answer to your excellent point is "I am assuming no losses".
We all know where it ends, when someone says "I am assuming no losses". But that is the big assumption behind this short article, and you do an excellent job pointing it out.
If I had more space to write, I would have expanded the article to address your second point: who pays for the loss IF there is one (and when is there never a loss?)
The answer is: the US taxpayer. The basic concept here is to subsidize downside risk at the expense of society. This runs exactly COUNTER to how an efficient capital market is supposed to work (punish and reward risk takers), because what I am suggesting is to give the risk taker the upside, and give the US taxpayer the downside. Doesn't this lead to a risk of over-investment (ie., another even larger asset bubble?)
Answer: yes.
Question: Why is Alex suggesting we even consider this proposal?
Answer: to get people to take risk again.
See, the real issue that I am seeing is that nobody will take risk at the moment. The capital markets cannot function unless people are willing to buy risk, and right now, that willingness is falling apart. What I am suggesting is to really offer an "unfair" good deal for homeowners and banks, give them all this upside and give the downside to the US taxpayer, as a means to get risk appetite up again. And once banks are back into the business of taking risk, and people are willing to put some capital into real estate (or other risky assets) again, you pull the plug on my "adjustable principal" program. Get the US Treasury completely out of the business.
My reasoning boils down to just this. I was walking to my office this morning, and went past a Starbucks. They were handing out free coffee on the street. So, I took a free cup, drank it, and went in later this morning to buy another cup. I'm suggesting Treasury basically offer the markets a free cup of coffee to get investors back in.
End of society? Maybe. We're already down that path. We'll get real close to the edge by the time this is all done.



On Mar 08 10:39 AM prudentinvestor wrote:

> Your idea appears to be an extension of the the cramdown laws just
> passed by congress, except that you would dispense with the formalities
> of a bankruptcy court ordering the principal write-down.
>
> The same vexing question comes up, who is supposed to pay for the
> loss? By custom, in orderly civilised society, profits are retained
> (after tax) by those who generate them, and losses are borne by those
> who incur them.
>
> These notions lead one to wonder whether civilised society, based
> on a sound and fair legal foundation of contract law, may be getting
> closer to its end. This would be too high a price to pay for temporary
> expediency.

Eight Reasons Bank of America Is Going to $20

When pigs fly. Listen, I just wrote an article suggesting potential for a nasty situation for short sellers, and mentioned B of A as a possible candidate for a bank with some upside to it. But the problem is that the United States is perfectly willing to step in an partially nationalize BAC, as they did with C and AIG. And today's stock market should tell you what happens over the short and near term when the US steps in as a big co-investor. It's ugly. The USA will buy up a bank or an insurance company ONLY because they know the magnitude of future losses is so severe, the government needs to put the company on the US balance sheet to avert bankruptcy and a collapse of the financial system. In other words, when the Treasury invests, it is not because they are bullish on the company. And they know more than we do.

The scenario with BAC can play in several ways. If it gets partially nationalized, kiss that baby goodbye. We see a share price around 40 cents within a few months. Or, if BAC survives, starts to write down some debts, make 'em easier to repay, enhance the credit quality of those smaller loans, take some tax deductions, you know, in time, BAC can go somewhere, rebuild some business, eat some of Citibank's lunch. Back up to $20? Maybe in ten or twenty years - again, assuming the happy scenario plays out and they don't get eaten by the Feds.

The author is dangerously happy go lucky. My advice is if you can afford to take a 100% loss on something, and want some ultra big time risk on your balance sheet, buy a small amount of BAC, and add JPM, Wells Fargo to the mix too, if you want. This will be the most speculative investment you will ever make in your lifetime, and it might go well, but there is a HUGE chance you walk away with a goose egg. And you might want to add a short financials ETF to avoid the 100% goose egg scenario.

The End of the Credit Crisis

Interesting point - especially since I'm a tax lawyer. Discharge of Indebtedness income (which is what you're talking about) will hose this Homeowner. This is one reason I've been writing to Treasury on an almost monthly basis, suggesting a five year "patch" for suspend income tax on unemployment benefits and D.O.D. income.

Look, our tax code wasn't designed for today's realities. Period. Get on board and write to your Congress person about cleaning up the system. I am.

On Feb 27 10:17 AM User 365522 wrote:

> The author fails to account for the tax effect on the borrower. The
> $200,000 write down by the bank is considered taxable income to the
> borrower, payable immediately. That will put the borrower into the
> highest tax bracket (which is going up even further). The tax owed
> will be about $80,000. Where does the borrower get that money? The
> bank survives, it stock price soars, while the borrower gets hit
> with a tax bill he can't hope to pay (or discharge through bankruptcy).
> Great plan!

The End of the Credit Crisis

THanks for your comment. That's correct. I'm using a story about individual loans for simplicity's sake only - what I'm focused on are mortgage pools and securitized vehicles, and the mark-to-market accounting rules. In an earlier draft, I bundled Homeowner together with some others, and did a securitization section. But the article ended up being too long and convoluted.


On Feb 27 11:00 AM User 75493 wrote:

> You miss one thing - individual (nonsecuritized) loans aren't written
> down until they distressed - usually 90 days deliquent. This loan
> is still on the books at 500k until the homeowner misses payments
> or the bank is sure the borrower isn't going to pay it back.
> Therefore, there's no "writeup" ahead, only writedowns for the bank
> in your story. And if the "smart guys" get their cramdown wishes,
> you'll see a reduction in lending as bank equity takes a hit. <br/>That's
> one reason why the gov't is going to be putting so much more equity
> into the banking system - there's a lot of impairment to be realized
> in the near future

The End of the Credit Crisis

Yes, this morning was an interesting development - too bad I wrote the article yesterday! If we take the Citibank move as a template for further partial nationalizations (which is what I think we'll see), then the Volkswagon story will not play out here.

Thanks for your comment.


On Feb 27 09:38 AM J. D. Swampfox wrote:

> The shares in the banks that the government owns are newly issued
> shares, not purchased from the existing supply in the market. Further,
> IF the banks take "write-ups" from the scenario you lay out, the
> value of them to existing private shareholders will have been diluted
> by the percentage controlled by the government. In the case of Citi,
> as of today, this is currently about 40%, but it looks increasingly
> like it will soon be 80% a la RBC in the UK. Skyrocket from write-ups?
> Sounds tenuous, at best...