Bank capital

[Rabbitisrich]

Munger, I'm not sure why you are focusing on BAC since your argument applies to the banking model. The problem with your argument is that it assumes that unsecured loans losses will increase and that banks will need to access the capital markets. As far as I can tell, you are saying:

 

1. Banks lend against their stock prices

2. Equity per share will be impaired when shares are issued at low prices

3. Unsecured loans aren't worth anything when they are worth nothing

 

Great thoughts!

[Munger]

"If you think unsecured loans are "air," then you must consider equites "less than air" since they rank behind unsecured debt."

 

I agree -- the value of equity becomes worthless when a company defaults on its debt.

 

"If that is the case how do you rationalise investing in stocks?"

 

I don't invest in overleveraged companies.

 

 

Listen -- I passed along a comment by Denninger.  After thought, I agreed with his assertion.

 

At this point, further debating w me is pointless -- the stock prices have collapsed in the past week.  If you've done good analysis -- load up...you should be loving this market -- you're gonna get rich if you're right.

 

 

 

[Munger]

Rabbitisrich -- you keep trying to twist my words.  As a result, you're not worth responding to...

 

Hope you do well with your bank stocks.

 

And here is one thought that is looking pretty good -- not buying BAC when Berkowitz was trying to tell everyone else to buy.

[PlanMaestro]

I am for free speech but also demand my right to keep reading efficiently the best investment forum in existence. Rabbitisrich is fighting the good fight but three times I stopped short from asking:

 

Is there a way to block some threads?

 

I could not stop asking the fourth time.

[rranjan]

I am for free speech but also demand my right to keep reading efficiently the best investment forum in existence. Rabbitisrich is fighting the good fight but three times I stopped short from asking:

 

Is there a way to block some threads?

 

I could not stop asking the fourth time.

 

+1

 

Thread is though easier to ignore in any forum except when you are getting the posts via RSS feed. Still if there is an option for ignoring a thread , it will be helpful for the reason PlanMaestro cited.

[seshnath]

During periods of STRESS, the capital associated with unsecured credit comes into serious question, which greatly heightens the risk of investments in bank stocks.

"I suppose contractual rights are worth nothing." -- here is the point, those contractual rights get you NOTHING if the borrower can't pay the bill, which guess what happens A LOT during periods of stress...there is no recourse and consequently, the capital is complete air. 

 

So wait -- "dealing daily with unsecured lending" gives you the ability to "claim" that the assets are really/honestly/i'm telling the truth secure because we banks make sure to only give unsecured loans to people who are secure...c'mon

Capital related to unsecured ledning evaporates during periods of stress.

 

You are right, in a very convoluted way.  Though, to equate market cap with equity coverage for lending is real nonsense.

 

Let us say, there are two banks.  Well Run  and City Slickers.  Both have the same size of balance sheet and lending.  The only difference is Well has lent only to people with high credit scores and City lent to sub prime borrowers.  Then there is a large scale default by sub prime and in the ongoing turmoil, people are selling shares in all banks at whatever prices they can get.  Now, I place a buy order for Well on a day for $0.01 per share and a desperate seller sold it to me at that price to raise cash (because he was one of the subprime borrower, may be).  According to mr. Denninger, Well is in deep doodoo because they cannot raise capital the next day except at $0.01 per share and hence they don't have adequate cushion against lending. 

 

The way to run a bank is not to need to raise capital when you are in trouble.  That is why Wells Fargo (not to be confused with Well Run) and JPM are admired for their culture and Citibank (not to be confused with City Slickers) and BAC is not.

 

The other key point that is missing in all the prior posts is the relation of loan loss reserves and actual charge-offs.  Compare that metric over a period of time, especially before 2008 and after; everything will be clear.  I don't really know if Denninger realises that the LLRs affect equity the way they flow through p&l each quarter.

 

Now, two reasonable people can disagree about the adequacy of reserves.  That is what separates men from boys.