najdorf

Berkshire Hathaway: Proof That the CDS Market Is Irrational

The idea that anyone can make any real money shorting and distorting heavily-covered large-cap stocks & bonds is the height of foolishness. There are huge pools of capital looking for undervalued investments all the time. If a struggling financial company were actually solvent, somebody would arrive with the refinancing option or new equity capital necessary to ride out short-term fluctuations. They would extract expensive terms and existing holders would be hurt, but there's a lot more money looking to buoy company solvency and lift pricing to accurate levels than there is looking to take apart healthy companies for short-term gain.

Over the past year+, every step downwards in pricing has been accompanied by bottom calls and inflows from value investors (private equity, Buffett's buys, foreign investment in C/MS, equity offering from GE & WFC, etc.). The fact that companies have continued to move downwards each time is due to very real problems in our economy and within these companies. On the back end some companies will survive and rise quickly in price, but more may still fail. At the start of this crisis people were saying things like "Sure WB and WM have problems, but C and BAC can NEVER fail; it's a sure double from current prices (~20 and ~35) if you can hold for 5 years". Does anyone still want to ride that train?

Investors may have become irrationally fearful about some companies (look at current pricing on MSFT/JNJ/T/VZ/etc - not as exciting as the banks but hard to imagine negative returns or returns inferior to treasuries for much longer) - but there are real reasons to be fearful about banks. People were scared to invest in banks long before anyone concieved of CDSs; the US had regular financial crises in any economic downturn for the first 150 years of its history. One of the major causes of this crisis was that we forgot that fear of banks after the success of reforms like FDIC and the relative lack of pain for large US banks in the S&L bailout/early 90s recession.