In Between Days: Bernanke, BAC, Buffett and Irene

by CC August 25, 2011 9:57 pm • Commentary



  • 8:30 a.m. ET: The Commerce Department takes a second crack (of many) at estimating second-quarter GDP. Economists estimate it will come in at 0.7%, exactly matching the first estimate. Go figure! We’d better hope it doesn’t get much worse.
  • 10:00 a.m.: The University of Michigan releases its final consumer-sentiment reading for August. If this economic report were a cocktail, it would be a tall glass of bitter, bitter tears.


  • Tiffany before the bell


  • 10:00 a.m.: You don’t really need us to tell you, do you? Oh, OK, Ben Bernanke will do some talking in Jackson Hole, Wyoming. He’s either going to break the market’s heart or shock and awe the world into never having another recession again, forever. Maybe something in between, I don’t know, I’m not an economist.


Business Insider

One could spend months peering into the depths of Bank of America and never know anything for certain. But here, in bullet form, is what I have concluded so far:

  • No one knows what Bank of America’s assets are worth—including Warren Buffett and including the experts opining all day on TV. The market’s collective assessment—that Bank of America’s assets are worth much less than Bank of America says they are worth—is probably the most meaningful estimate out there. Bank of America itself may have a better idea of what its assets are worth than the market does, but Bank of America is keeping critical information secret.
  • Assessing the value of Bank of America’s assets is extraordinarily complicated, and Bank of America has not disclosed enough information for even super-sophisticated bank analysts (or Warren Buffett) to reliably do it. Bank of America has published a mind-boggling amount of detail about its assets and business, but according to several professional bank analysts, this is not nearly enough detail for any outsider to really know what’s going on.
  • Bank of America’s balance sheet is so huge—$2.2 trillion—that even a 5%–10% “haircut” to the value of its assets would result in write-offs of $100-$200 billion. This would zero out Bank of America’s tangible equity and wallop its book value.
  • Bank of America’s stock is behaving exactly the way the stocks of AIG, Lehman Brothers, Bear Stearns, Wachovia, and other doomed financial institutions behaved in the early stages of the financial crisis. Which is to say, the stock keeps dropping, with intermittent rallies, while management keeps insisting that everything is okay.
  • Bank of America’s management is behaving exactly the way the managements of AIG, Lehman, Bear, Wachovia, and other doomed financial institutions behaved in the early stages of the financial crisis. Which is to say, they are indignantly insisting that everything is okay and blaming their stock price declines on “shortsellers” (and me). Thankfully, now, with the Warren Buffett deal, they are finally facing reality.
  • Bank of America has several categories of assets that might well be worth less than Bank of America says they are worth. Taken together, these add up to big numbers.  The categories include (but are probably not limited to):
    • $17 billion of European exposure, including $1.7 billion of sovereign debt of PIIGS countries
    • $67 billion of net “derivatives” assets—(~$1.9 trillion before netting). Derivatives are what Warren Buffett once referred to as “financial weapons of mass destruction.” No one outside Bank of America knows what’s in them, what they’re worth, or what might cause them to explode. Derivatives played a role in killing Lehman and AIG—and no one on the outside of these companies had any idea what was about to hit them.
    • $78 billion of “goodwill,” which is the residual carrying value of acquisitions Bank of America made long ago. This goodwill may or may not be worth anything.
    • $47 billion of commercial real-estate loans, per two analysts
    • $408 billion of residential mortgage loans (as of Q1), comprised of $274 billion of first mortgages and $134 billion of Home Equity Lines Of Credit, per one bank analyst (more on these below).
    • Some of the above assets roll up into…
    • $73 billion of “level 3” assets, which are carried at extremely subjective valuations (These assets don’t have freely traded market comparables. It was this category of assets, in part, that killed Lehman Brothers)
    • ~$500 billion of “level 2” assets, whose values are determined with models (which, in turn, are driven by assumptions that may or may not be conservative).
  • All of these assets are balanced against about $230 billion of shareholder’s equity (“book value”) at June 30, including Buffett’s investment.  $230 billion of shareholder’s equity may sound like a lot, but it’s not when measured against the size of the balance sheet ($2.2 trillion). Again, a 5%–10% haircut in the value of the assets would blow a huge hole in the balance sheet (or, if the hit is spread out, depress earnings for many years).
  • It is not just Bank of America’s reported assets and liabilities that could clobber the company––it’s the unreported ones.  Think back to why Lehman, AIG, and other financial firms imploded with little warning: A big contributing factor was the “collateral” the companies suddenly had to come up with to satisfy derivative contracts no one knew existed. No one knows who the counterparties for Bank of America’s $1.9 trillion of derivatives are. No one knows what the terms of these contracts are. Hopefully, we’ll never know––but if things get bad enough, we might suddenly find out.
  • It is now the consensus of Wall Street analysts that Bank of America needs to raise more capital––the only question is how much. A couple of months ago, most analysts were saying that Bank of America had plenty of capital. Now, even Bank of America bulls are arguing that its capital needs are “manageable.”  This, too, is reminiscent of the fall of 2008, when analysts moved from insisting that financial firms had plenty of capital to saying that they needed capital to watching them go bust. Most analysts think Bank of America needs a lot more capital than the $5 billion Warren Buffett just injected into it.  I wonder what the Bank of America consensus will be in a few months.
  • It’s certainly possible that the market is wrong about Bank of America and that, as management insists, everything’s fine.  Sometimes the market is wrong. Sometimes the market just gets nervous for a while and then gets comfortable again. Perhaps that’s what’s happening this time.
  • But Bank of America’s management is not behaving as if everything is fine. I’ve been observing management teams for two decades now.  Generally, the more management teams make their communications about “shooting the messenger” (often a shortseller or skeptical analyst), the more likely it is that the messenger has hit close to the mark. The mud-pie that Bank of America threw at me earlier this week, in my opinion, was a classic example of shooting the messenger.

So that’s what I’ve concluded about Bank of America so far. Again, this does not mean Bank of America is hosed––and as a Bank of America shareholder and American taxpayer, I certainly hope it isn’t. It just leaves me concerned that the market is right about Bank of America and Bank of America management is wrong.

Bronte Capital

The credit default swap (one year, illiquid) says that BofA is having some trouble financing itself. People are willing to pay 4 percent for a one year BofA default bet.

But absent that (rather hairy) data point I lean on the fact that the “too big to fail” rules of the game are well understood at the moment whether Yves Smith or Paul Krugman likes them or not. No big bank in America is going to be let fail. Ultimately the credit of Bank of America is synonymous with the credit of the United States of America and last I looked at US bond pricing that credit was good.

In other words BofA has enough capital to raise money in the bond market because its real capital is not something on its book. Its real capital is faith and credit of the United States. And because of that the bank won’t fail through a wholesale run. Besides Bank of America has a lot of short-term liquidity. Not enough to save them from a mega-catastrophic run of course but they can deal with most things and a mega-run relies on the too-big-to-fail consensus breaking down.

The only capital risk to BofA then is one that regulators find them poorly capitalized and force them to raise capital or the like. That is definitely possible but in my view unlikely.

It would happen if BofA were to book a sudden 50 billion in provisions for mortgage-fraud settlements. But that is the legendary self-assessed exam where the penalty for failure is death.

You see these are litigation losses not credit losses and the one thing that everyone agrees on about litigation is that it is slow.

For Bank of America slow is good. Very good. You see BofA has more than 10 billion dollars in pre-tax pre-provision earnings every quarter. This number is falling but it still very large.

If Bank of America really has 50 billion – no – lets get really bearish – 70 billion in additional losses to take but the litigation lasts seven years it will eat only a quarter of the pre-tax, pre-provision earnings over that period. It will dampen earnings but can’t cause BofA to run short of regulatory capital.

And I am pretty sure they could stretch the litigation five years if not seven. I have seen court cases where discovery lasts that long.

So in summary Bank of America won’t fail because the market does not want to fund it. It is “too big to fail” and its credit is really the credit of the US Government. And it can’t fail because it needs to take too many losses too fast and runs out of regulatory capital. These are litigation losses and they offer plenty of time for deferral against future income.

In other words this Bank of America panic is just a panic.

And at the risk of sounding like Jim Cramer: Buy.

Business Insider

In an editorial to the Financial Times, PIMCO’s other chief, Mohamed El-Erian argues that Bernanke should stave off another round of easing:

“…Rather than embark on another policy initiative (“QE3”) with questionable net benefits, it would be better for Mr Bernanke to use his Jackson Hole speech to reframe the national policy debate and, in the process, set the stage for President Barack Obama’s key economic announcements on September 5.

He should do so in three steps. First, acknowledge that the considerable headwinds undermining economic growth and jobs have important and growing structural elements. Second, explain why a sustainable solution must go well beyond Fed financial engineering and, specifically, incorporate co-ordinated structural reforms on the part of agencies responsible for housing, the labour market, public finances, infrastructure and directed credit. Third, and most delicate, caution that another round of unconventional Fed policies would only be effective if accompanied by these other policy initiatives.

Jim Paulsen of Wells Capital Management also argued against QE3:

“We have created a very bad precedent… The financial markets whine and policy officials jump. The Fed has become the Pavlov’s dog of the stock market, and this is a horrible precedent for policy makers.”

Meanwhile John Silva, chief economist at Wells Fargo said the economy needs structural changes (via Marketwatch):

“The Fed has shot the big cannons. They are now playing the game with smaller ammunition

Mick Levy, chief economist at Bank of America followed in the same thread saying he hoped Bernanke would discuss that mere changes to monetary policy would be inadequate to boost the economy (via Marketwatch):

All the targeted counter-cyclical stimulus is not going to address the huge pocket of distressed properties… The slowdown is not the fault of not enough liquidity.”

Earlier this month Nouriel Roubini said the Fed would announce QE3 (via WSJ):

He will announce at Jackson Hole even more quantitative easing… Some variant of additional monetary easing. Keeping the fed fund rate at zero is one step. Buying more treasuries is another one. Trying to target directly the long-rates is another one, price-level targeting, lengthening the maturity of treasuries there is a combination of policies. We’ll have QE3, maybe QE4, maybe QE5 if we’re in the long haul of near depression.

He also took to twitter to say QE3 had begun in Japan and Switzerland with their currency interventions. He added, “The Fed will eventually get to QE3 but it will be too little too late.”

Jan Hatzius of Goldman Sachs who is believed to be one of the best forecasters on the U.S. economy said despite internal dissent he expects a third round of “conventional quantitative easing”:

“We disagree strongly with one argument against further QE that we heard frequently today–namely that the three dissents from Presidents Fisher, Kocherlakota, and Plosser indicate “the end of the line” for further Fed easing and difficulty for the chairman to get his way. On the contrary, we view Chairman Bernanke’s willingness to live with the dissents as a strong signal that he and the rest of the Fed leadership view the need for renewed easing as more important than the institutional norm of consensus decision making. There is no question that Bernanke will always have enough votes, and we fully expect him to use these votes to provide further support to the economy if he views it necessary.

European Central Bank president Jean-Claude Trichet, MIT professor Esther Dufflo and Harvard University professor Dani Rodrik will also speak at Jackson Hole this weekend.

NEW YORK (AP) — New York City officials say they’re preparing for the total shutdown of the nation’s largest mass transit system.

Mayor Michael Bloomberg says officials expect to shut down the city’s entire transit system at some point Saturday afternoon ahead of the arrival of Hurricane Irene, which is now forecasted to strike eastern Queens. He says service likely won’t be available again until sometime Monday or perhaps later.

Metropolitan Transportation Authority Chairman Jay Walder says that the system can’t be safely operated with sustained winds of 39 mph or more. He says it will take at least eight hours to move all MTA equipment from low-lying storage areas and secure trains in protected areas, including in the system’s underground tunnels.

Bloomberg is urging residents of the city’s low-lying areas to begin evacuating tomorrow. He’ll decide whether to issue a formal evacuation order by 8 a.m.