ERICOPOLY

The way to get around the capital gains deferral issue is to (instead of using calls) buy the extra common using margin loan and hedge the size of the loan with LEAPS puts. Just make sure it's a "portfolio margin" account instead of a "Reg-T margin" account. This way you will most likely have eliminated the problem of taxation when rolling. You also capture all of the dividend -- so certainly there is no longer any sort of paranoia about missing out on it. Interactive Brokers has really cheap margin rates. I pay less than 1% annualized margin interest rate. Here is what I wrote to racemize in private mail a few days ago: I looked up the cost of the $12 strike put that expires in 2015. $2.04 is the "ask" -- roughly 10% annualized cost for the put. So the cost of leverage (at 1.5% margin rate), winds up being 11.5% roughly for the margin+common+puts strategy with Interactive Brokers. That includes full dividend protection of course. So that's the most comparable to the warrant. Still scratching my head -- at-the-money costs about 11.5% annually and 40%-out-of-the-money costs a bit more than 4% annually. EDIT: And at the rate that IB charges me, my annualized cost is less then 11%. Roughly 10.75% is my cost. So yes, rates may go up despite what Berknanke says, but keep in mind that it's 13% cost embedded in the warrants for the entire 6 years, and currenly 40% out-of-the-money BAC puts only cost 4% annualized including the current margin interest rates. So that's a gap of something like 9% -- the distance between 4% and 13%. Lot's of protection from rising interest rates embedded in that assumption.

I'm get the feeling that it's hard to believe somebody with little investing talent can have made extremely high returns. There were a few times when it seems like a Lallapallooza moment had arrived, and I took a really big crack at it. I wasn't even looking for these opportunities. This board just tends to get very excited when these things come along -- fortunately, I understood the proposition well enough to take full advantage. I am about the laziest and most underserving of these returns if you were to see how I spend the day. Right now, such as with SD, there is a lot of excitement but I just don't have a clue -- so I'm not getting involved. That might be the best ever investment yet, but I just don't know drilling from a hole in the ground. I don't have an options strategy where I go around looking for a nail to pound. I'm not even actively looking for nails. I don't know when I'll have the next 20% year, let alone the next 75% year. Maybe never on both counts. I only brought up my returns because it just so happens that it is rather interesting what a few well-timed investments can do -- and the ideas came from reading this board so I thought it worthwhile sharing. You can think of it like one of those wax museum displays if you like -- just a rubber necking opportunity, but otherwise I'm not professing to be of any special talent.

How do you figure this? Can you paraphrase or direct me to the argument? Here is one of the arguments, and perhaps the strongest: 1) The most likely scenario being that the stock goes up over time.... 2) The puts in the LEAPS strategy can get rolled to higher strikes. 3) Stock price crashes and your puts are at higher strike. There it is. Meanwhile, all along you had less money on the table. Less at risk, safer strategy... what's not to love?

Normally the options are priced such that on a straight-line depreciation basis the longer term ones have cheaper annualized cost of leverage. Your proposal would work if the market price of the stock made a large movement, but it would be inferior if the stock price were completely flat. This explains why more volatile stocks have more expensive options.

I believe the next 10 years of stock market returns will depend on corporate earnings for the next 10 years. The Shiller PE10 argument suggests that if earnings were substantially lower in the recent past 10 years, then they'll undergo a period of weakness over the future 10 year period and that's what is going to kill stocks. I take this attitude because the current year P/E is not all that dangerously high. The argument rests on profit margins being at all time highs, or artificial stimulus, etc... Things won't be that bad if the profit metrics don't unwind -- the PE10 argument is basically predicting that they will. So it says, in effect, corporate profits don't suddenly "just up and get this good" so quickly. Maybe it's right, but I think it's better to just have an argument over what is driving the currently high profits and take it from there.

Do you think it is possible that BAC got attached by some activist investor and got Moynihan fired? I notice activists are more active these days. I believe an activist wants to buy shares and then quickly sell at a profit. Wash, rinse, repeat. So fast turnover/outcome/resolution is optimal. So he wants Moynihan to settle the legal issues as quickly as possible. Thus, pay a bit too much and just be done with it for a quick pop. Activist then sells on the pop and you never hear from him again. No, I don't think an activist would approve of what Moynihan is currently doing by dragging out the legal process -- if you bring one in for me, maybe we'll get a settlement soon and shares will recover. Now, what I really believe, is that even if this MBI issue is settled you will see hardly a whimper from the stock -- this is because the issue of the earnings per share is still not settled. That's what I think is really holding the stock back. However, as long as I'm waiting for those earnings to recover, I hate this legal uncertainty as much as the next person. EDIT: Again, I'm reticent to openly disapprove of Moynihan "dragging out" the legal process because once again, I don't understand the underlying legal process strategy that well. So I'm just voicing my ignorance (but that's probably already perfectly clear).

See, if I were running BAC I could make my life easier by just quickly settling these cases for perhaps a few billion more than optimal, then go play golf. After all, the bonuses and big pay come rolling in even if I waste a few billion too much settling up lawsuits. And yet Moynihan doesn't do this. It's no skin off his back, it would just be shareholder money. And yet he doesn't do it. So there's that argument too -- if he doesn't care about the shareholder, he could at least care about himself and get more tee time at the Country Club.

This will probably expose me for how little I know (and it's not much!), but my concern is whether the $8.5bln settlement objectors would be strengthened if BAC started to settle with MBI for 100% on the dollar.

I'm sorry I mentioned it because I'm not going to provide any details. It's going to remain buried. I still respect the guy's opinion (when it's not a slight directed at me).

I'm not saying what you said was illogical. I'm saying that the "irony" is that while you suggest I'm being optimistic about how BAC can handle a much larger settlement, what I'm really doing here behind the scenes is biting my nails and being grateful that BAC is still accumulating capital given that we're still not with a settlement in hand. So basically to rephase, it's ironic that I've spend the past couple of weeks worrying about this very scenario but then you mentioned that I appear to be rather unconcerned about their being able to handle a bigger settlement. I too want them to settle and have this risk behind them. I fully agree it's worthwhile to just eat a billion extra here or there to eliminate the possible tens of billions of risk here. I've heard you time and again state that you both want them to get this behind them at perhaps an extra billion in cost, while at the same time boost capital return. I fully understand that your statement is both actions taken as a whole. You don't want them to both leave this huge exposure to risk as well as return capital -- you want the $1b or so extra settlement hit which costs them pennies per share, as well as getting the boost to capital return after they've got it behind them. A single transaction (sorry, tech speak), not one without the other. I am not disagreeing with you or trying to tit for tat arguing -- I fully respect your opinion and also wish Moynihan would just do it because I can't believe we're still needing to discuss this at this point given they can fully afford to get it behind them. But I just am less vocal about it because I don't fully understand the legal positioning or whether if they pay MBI "too much" others will also want more. But for an extra billion over whatever they think they can settle for -- I guess it would be a billion well spent, and better spent perhaps than the billions they handed over to Buffett. You know, I once criticized the Buffett deal maybe a couple of months ago, as well as that December '11 capital raise at $6 per share, and a well respected board member sent me this scathing rebuke in personal email. So maybe he'll harass you too :( No worries, he can just be ignored but I just thought you might understand why I stopped being so critical.

Funny you should mention that. I started reading the Fairfax letters again the past couple of weeks and bought up some FFH using portfolio margin (hedging out BAC risk with at-the-money puts). Then I also have some MBI exposure from writing puts (this time to purchase some $10 strike BAC hedges). It is quite interesting to me that it is more expensive to insure MBI at $3 strike than to insure BAC at $10 strike. Ironically though, while you were complaining that Moynihan didn't ask for enough capital return I was quietly relieved given that these legal reserves might need more boosting.

There was a comment made that Moynihan had more recently praised Fannie Mae executives in late 2012 public appearances, and that good will gesture helped the parties reach a settlement. You comment here about BAC dragging people at NYDFS through the mud I believe is valid, because it will create personal ill will such as you describe. Likewise, Jay Brown's trash talking might have turned this into a personal vendetta for the BofA executives. He hasn't exactly kept the language clean and professional. But I'm actually 100% in agreement with you on just taking the hit, settling, and moving on. But I don't pound the table for it as hard because I feel like I don't fully understand the nuances of why they might be reticent. I hope it isn't simply because Jay Brown is publicly being an asshole towards the BAC management, but who knows. If you think NYDFS could take something personally, then why not BAC?

Sorry, I never saw this reply of yours -- but when the thread got bumped today, I just noticed it. For scenario 1, it means there will be the same number of underlying shares but fewer of them are hedged. So that would mean taking delivery on a portion of calls, and rolling the rest. For my margin account (portfolio margin), it means taking delivery on all of them and buying puts on just the right amount in order to keep the margin loan hedged. For scenario 2, that depends. May or may not. I might benefit merely from the lower cost of rolling (due to skewness), or I might choose to increase leverage. Or might choose a lower strike price when I roll. Not sure what I'd do, but lots of flexibility available.

I think everyone is treating the "precedental" nature of previous settlements as equivalent to "reasonable". Who's to say any previous settlement amounts have been reasonable? If MBIA can recover $X in 2015 through legal action, then why isn't a "reasonable" settlement just that number discounted back to today and adjusted for whatever level of uncertainty they feel with their chances of winning? I think it is easier to believe that regardless of what "reasonable" is, BofA probably has more leverage by holding MBIA's feet over the fire on the possible future receivership of MBIA Corp. I thought they didn't have that leverage because of the threat of what an adverse ruling means for them (per Cardboard).

The key part of your statement being "as soon as the ruling comes out". And when would that be? Today, nobody is suing BAC for $100 bln. That lawsuit first has to be filed. And nobody can even do that as long as the $8.5bln settlement has yet to be tossed. So do you think a major case like that will be filed and decided all within 12 months? Or 24 months? I put it at 3 years in my estimate, but it could well take longer than that. And suppose it's only 24 months. That would leave BAC at about a 7% capital ratio. They most recently had a ratio somewhere in that neighborhood just a year ago if I recall correctly. I didn't spend too much time on article 77. Is it not for getting back all the loses for the investors? My understanding is that BAC agreed to settle for $8.5bln, and that all of the injured parties are bound to the terms of the settlement unless they can get the settlement tossed in the article 77 proceeding. After that point, and only after that point, can they then proceed to go after BAC on their own with a new round of lawsuits.

I think he is treating Uncle Sam differently than MBIA. MBIA is liquidity strained, so if he drags the case long enough, MBIA will not be able to pursue 100% claim plus interest. However, Uncle Sam has unlimited staying power, and has the leverage of pursuing criminal charges. That is totally different. He has settled with private parties. For example, AGO != Uncle Sam AGO got about 50% to 66% on the face. There are rumors saying BAC only wanted to settle with MBI for $1 bn, which is 25% on the face. AGO is in a much stronger financial position than MBI, so maybe I should say, BAC is treating parties that has a strong staying power differently than parties with a weaker staying power. In early 2012, if I remember correctly, Jay Brown said he expects to either settle with BAC in 2012 for 66% of the face, or 100% in 2013 through litigation. So I wouldn't say Jay Brown is unreasonable. (Maybe it is Bruce Berkowitz who said that instead of Jay Brown?) The point I was trying to make is that AGO didn't have the leverage that you claim the government has, and yet BAC still settled with them. You wrote: Uncle Sam has unlimited staying power, and has the leverage of pursuing criminal charges. That is totally different. I believe your point was that BAC is unwilling to settle on reasonable terms unless the party has unlimited staying power. Well, I didn't see AGO as fitting that description. EDIT: I guess I would like the comparison more if you can explain how MBI doesn't have the amount of leverage that AGO had. I think you were overplaying your hand by comparing MBI with the government -- rather, I would find it more reasonable to compare MBI with the other private parties that BAC has settled with, such as with AGO using my example. You might still have a point, but unlimited staying power or threat of criminal charges isn't what supports the point.

The key part of your statement being "as soon as the ruling comes out". And when would that be? Today, nobody is suing BAC for $100 bln. That lawsuit first has to be filed. And nobody can even do that as long as the $8.5bln settlement has yet to be tossed. So do you think a major case like that will be filed and decided all within 12 months? Or 24 months? I put it at 3 years in my estimate, but it could well take longer than that. And suppose it's only 24 months. That would leave BAC at about a 7% capital ratio. They most recently had a ratio somewhere in that neighborhood just a year ago if I recall correctly.

I think he is treating Uncle Sam differently than MBIA. MBIA is liquidity strained, so if he drags the case long enough, MBIA will not be able to pursue 100% claim plus interest. However, Uncle Sam has unlimited staying power, and has the leverage of pursuing criminal charges. That is totally different. He has settled with private parties. For example, AGO != Uncle Sam

There is no way that it's dead. Any ruling against BAC gets appealed, and the settlement amount would go up. BAC is at something like 9.5% capital ratio today under basel III. Every 100 bps of capital ratio is about $14bln. Let's say the settlement grows from $8.5bln to $40bln. That's about $31.5 bln increase, or 225 bps of capital ratio. So it drags them down to 7.25%. Hardly dead by any stretch, even if they had to immediately boost reserves $31.5 billion. At that point, BAC only needs to boost it's capital by 125 bps to get back in the game for capital return. That would take only $17.5 billion pre-tax earnings. At current pace, that would take about a year. So they can be at 8.5% Basel III by this time next year even if they today announce that they are boosting their settlement reserves all the way to $40bln from $8.5bln. Then if the appeals process takes 3 years, you can up the amount to at least $80-$90 billion with BAC still painting it's nails. But as soon as the ruling comes out, BAC has to deposit the money into a trust account during appeal time, and pay about 9% interest on that. BAC cannot afford to have $100 bn deposit into a trust account. That would be the entire common tangible book value of BAC. Though I think the probability of this happening is less than 1%, we all know it is greater than 0%. Why would BAC take such a risk of a potential wipe out, just to save about $1 bn more by not settling with MBIA immediately? I don't think there's any real possibility for the entire 100 bn amount, or at least, other than you, I haven't seen that mentioned. Eric's 30 billion came from Mayo, I think. Plus, there are all the trust issues that MYDemaray and xaxp have discussed, if the 8.5 bn settlement doesn't go through. Mayo said $30bn. I upped it to $40 just to show how a big number can be digested rather calmly.

There is no way that it's dead. Any ruling against BAC gets appealed, and the settlement amount would go up. BAC is at something like 9.5% capital ratio today under basel III. Every 100 bps of capital ratio is about $14bln. Let's say the settlement grows from $8.5bln to $40bln. That's about $31.5 bln increase, or 225 bps of capital ratio. So it drags them down to 7.25%. Hardly dead by any stretch, even if they had to immediately boost reserves $31.5 billion. At that point, BAC only needs to boost it's capital by 125 bps to get back in the game for capital return. That would take only $17.5 billion pre-tax earnings. At current pace, that would take about a year. So they can be at 8.5% Basel III by this time next year even if they today announce that they are boosting their settlement reserves all the way to $40bln from $8.5bln. Then if the appeals process takes 3 years, you can up the amount to at least $80-$90 billion with BAC still painting it's nails.

Well, now Alison Frankel validates my thinking -- so that won't help my "misunderstanding of how these negotiations are done" much: http://newsandinsight.thomsonreuters.com/Legal/News/2013/04_-_April/In_BofA_death_match,_MBIA_wins_a_round_at_N_Y__appeals_court/ The bank, as I see it, believes MBIA is demanding nearly 100 cents on the dollar for its claims that Countrywide (and BofA, as Countrywide's successor) breached insurance and servicing agreements on mortgage-backed securities MBIA agreed to insure. Maybe at this point I'm being held back by the thinking that BAC will be trading over $20 in a few years no matter how these trials work out, but MBI will be over $20 in a few years only if this trial works out. So I see BAC's path as more certain. Although, it does seem rather certain that MBI will eventually prevail. I have a few questions about MBI though -- now that they've been unable to write premiums for this long is it going to be as simple as hitting a switch, or will it be slow to rebuild their brand/share? I don't know. So there are a few questions that I don't understand, and I'm not sure that it's a better decision to sell some BAC and buy MBI. But I hope MBI works out great because I want the board members here to make good money. I feel like I can be disgusted about Jay Brown's trash talking while at the same time wishing you all the best success.

Neither did Florida though. However there may be other reasons why you won't have a problem, but the non-recourse issue doesn't seem to be the source of the problem in the US (if it was, then why wasn't Florida spared?).

I guess the Berkshire Hathaway report, at only 112 pages, would be the much longer of the two if it provided an equivalent amount of information about each subsidiary.

I don't need to be told this. This is not an area where I disagree. Thus I don't complain about the settlements that they've made thus far. The kind of thing that I hate is when a bad actor points a finger at another bad actor, and meanwhile declaring himself clean. That's really what I'm complaining of. You can see it in his letters where he explicitly calls BofA a bad actor in the financial crisis... this coming from someone who knowingly wrapped Countrywide's bad loans hoping to: A) pocket the premiums if loans don't go bad B) just rely on the courts for R&W claims if they do go bad. I feel like if people who tried this sort of thing bore the consequences of their counter-party's solvency, then a lesson would be taught in doing due diligence for the loans you agree to wrap with insurance. It is relatively expensive for society to protect people through the courts who knowingly wrap bad loans as a no-risk strategy. Thus, a bad actor gets away with it. I wish things worked out differently for him and he could be taught a lesson in responsibility. Mostly, because he continues to run his mouth about this being BofA's cause and not his own. A little bit of admission of guilt from him and I'd be fine with it. But if we walks away from this bearing 0% of the losses, and no admission of guilt, I might feel a bit like another bad actor walked away from the crisis without a scratch. Now, would a good actor knowingly wrap a bad loan from Countrywide with the attitude that if it goes bad he'll just take it to the courts for for R&W recoveries? This isn't related to my being a BAC shareholder -- I'm happy for them to pay their share per all the rest of the settlements. 100% is where I draw the line, because it just rewards people like Brown for their seedy strategy. Of course, this all assumes that Brown knew Countrywide was underwriting sub-par loans. I guess that can just be my assumption that I cannot prove.

I'm not sure. Could very well be a good bet. However in late 2011 I had equal parts MBI and BAC. I sold all of the MBI in the $9 range and put it all in BAC. Txlaw asked me why and I told him that I thought Jay Brown was being irrational in asking for 100% recovery and it would get dragged on forever. So, what I said could have been absolute drivel, and what may have passed could have been pure luck, but so far I'm happy I did that. I don't know if the BAC management is being at all emotional about this trial, but if they are, I'd bet it's because they don't like Jay Brown's tone given that Brown put himself in this position whereas the guys he's throwing stones at, BAC management, are new in their jobs and are just trying to clean up their predecessor's mistakes. Plus, MBI made a deal with Merrill Lynch at the time when BAC didn't own them, so it has nothing at all to do with whatever Countrywide did or has not done. From as far as I can tell, the internet doesn't agree with me -- people seem to believe MBI is being beaten down by the mean bully BAC. But then, isn't that why the MBIA CEO writes those scathing shareholder letters? I guess it is dirty, but it works. One thing about Jay Brown, and then I'll go back to staying silent on MBIA. From the proxy: Under the terms of the employment arrangement Mr. Brown entered with the Company when he rejoined the Company in February 2008, Mr. Brown received an annual salary of $500,000 and a maximum annual incentive bonus of $2,000,000 payable based on performance as determined by the Compensation Committee. He was not eligible for any LTI awards or for a change in salary during the term of this employment arrangement which lapsed on December 31, 2012. On February 18, 2013, Mr. Brown forfeited 2,925,990 shares of restricted stock of the Company that were awarded when he joined the Company in 2008 and approved at the Annual Meeting of Shareholders on May 1, 2008. The grant provided for full forfeiture of restricted stock if the Company’s common stock did not maintain an average closing share price in excess of $16.20 on each day of a consecutive 20-day period on or before February 18, 2013. Such condition was not met resulting in the forfeiture of these shares. Mr. Brown does not have an employment or severance agreement and is not entitled to any benefits or other payments in connection with any change of control of the Company. Mr. Brown’s salary was increased to $1,000,000 for 2013 and, as noted above, Mr. Brown requested that the Company not take any action with respect to any 2012 bonus. Mr. Brown’s base salary was adjusted to bring it in line with the market median base salary. I'm happy Jay Brown is looking out for shareholders and not just himself. I'm pretty sure BAC management is well aware that Brown would be financially hammered if he did not cave to BAC demands. So who's bullying who here? The one that is being bullied is the one that is already toast in the alternate reality where BAC never bought Countrywide. They're now basically complaining that the lifeboat is trying to toss them overboard -- which may be true, but keeping in mind that they should have already been drowned. Anyways, I'm working off of the assumption that Countrywide on it's own does not have the money to pay all of these R&W claims in total. This is the risk that Brown's company tied their future to. That should have been their fate for taking on so much risk with such a weak counter-party. They basically are getting saved (creating a the moral hazard?) by the court system which is going to make BofA backstop Countrywide. I guess I strongly suspect that industry insiders (such as Brown) knew that Countrywide wasn't the world-class company that Mozillo still claims it to be, but they kept on dealing with them anyhow. It seems a shame that he can pocket the premiums if defaults don't happen, and can take BofA to court (instead of just Countrywide) when defects do happen. That seems unethical if he knew the loans were garbage in the first place. He would have been punished for this properly if his only recourse was to Countrywide. That counter-party risk creates a need for due-diligence which would help prevent this kind of financial crisis in the first place. And Brown's letter singles out BofA as a bad actor in the financial crisis, seemingly taking no credit for his own role in the game.