Monday, July 28, 2008

Merrill takes a(nother) giant writedown

Here's an email I wrote tonight:

How can anyone still believe one word that comes out of these guys' mouths? Merrill's raising another $8.5 billion of capital after pounding the table for six months that not only were they adequately capitalized, they are over-capitalized. Not even two weeks ago Thain said he was comfortable with Merrill's capital position. I don't think we can remotely believe the market value of bank balance sheets. Merrill marked this $30.6 billion notional value CDO portfolio at 36 cents ($11 billion) on June 30th and four weeks later sold it for 21 cents ($6.7 billion). That's down 42% in four weeks!!! This isn't some rounding error position on their balance sheet...and they financed the sale with 75% seller financing, so the true price is really below that! Holy krike! These are remarkable times, I hope everyone is storing this in their memory bank somewhere since there are a ton of lessons in this banking epoch. Crazy.

I don't know when this deleveraging negative cycle will end, but as leverage goes away, bankers (both "i" and "commercial") are going to demand bigger and bigger spreads on loans which is going to continue to put downward pressure on multiples (upward pressure on cap rates), which is going to put pressure on asset values, which is going to put pressure on existing loan prices, which is going to pressure banks' balance sheets, which is going cause further deleveraging, repeat, etc. etc. We may literally be seeing a fundamental change in the way banks are operated for the next generation.

Anyway, here are Thain's quotes. He's either a boldfaced liar or these guys still don't have a handle on what they own and what it's worth (probably more of the latter with a sprinkle of the former).
Thain Quotes on Merrill's Capital Adequacy

Roger Lowenstein on the GSE's and socializing credit risk

Roger Lowenstein, who has brilliantly written the definitive books on topics ranging from the collapse of Long Term Capital Management and the tech bubble to the life of Warren Buffett, discusses the dangers of socializing Fan and Fred in this past weekend's NY Times Sunday Magazine. Succinct and spot on.

Lowenstein's No Free Bubble

July 27, 2008
The Way We Live Now
No Free Bubble
The short take on the economic crisis of the 1970s was that regulation failed. Price controls failed; high taxes failed; regulation was outmoded.

The mortgage and banking crisis of 2008 feels diametrically different. What failed this time were markets. The lenders who were supposed to regulate mortgage borrowing — and the credit-rating firms who monitored them — failed utterly. The investors whose job it was to monitor the capital of financial institutions were asleep at the switch.

It is not really that simple, because investors were encouraged by the creeping government doctrine of “too big to fail.” But if, after the ’70s, the solutions in one way or another were about opening industry to the fresh breath of markets, today the remedies issue from Washington. It is quite possible that the great experiment in laissez-faire has, for this generation, run its course.

The Federal Reserve and the U.S. Treasury have lately widened the federal safety net more quickly and more aggressively than at any time since the New Deal era. Indeed, a recent front-page headline in this newspaper, “Confidence Ebbs for Bank Sector and Stocks Fall,” had distinctly Depression overtones. (You could almost envision the next line: “Hoover Urges Calm.”) And not since the Depression (under the Reconstruction Finance Corporation) has the government bought significant equity in private firms, as the Treasury has sought the authority to do in the case of Fannie Mae and Freddie Mac. At least during the 1930s, legislation followed months of deliberation and public hearings. The proffered fixes to today’s fast-moving crises are worked out hastily and in private.

At a visceral level, it is deeply upsetting when institutions that once reaped fabulous profits (a goodly share of which were snared by their executives) are granted the protection of Uncle Sam. Robert Rodriguez, the C.E.O. of First Pacific Advisors (which has a fund I’m invested in), confessed to a “sickening” feeling at the news that the Treasury might guarantee the debts of Fannie and Freddie. Rodriguez was one of the few fixed-income investors who, having noticed the bloated balance sheets of the mortgage giants, refused to buy their debt securities. Ordinarily, less prudent investors would have suffered a loss; instead, any pain will be borne by the taxpayers.

More troubling than the unfairness is the potential that the solutions will exacerbate moral hazard: that people who feel inoculated will run greater risks. As Rodriguez observed: “Nobody wants to take the pain for excesses. Each time the problem gets bigger.”

The entire U.S. policy of promoting homeownership, which during the boom raised the ownership rate from 64 percent to 69 percent, now looks to be a case study in unintended consequences. Encourage more housing than markets will support and you get — voilĂ ! — mortgages that fail. Fannie and Freddie were among the chief implements of the policy. Though judged by Standard & Poor’s to be only a Double A-minus credit, they were able, thanks to the widely held belief (since validated) that the United States would not allow them to fail, to borrow at lower than Triple A rates.

As the balance sheets of the agencies swelled, they grabbed the profit margin that traditionally went to savings and loans. The thrifts complained, but they were no match for Fannie and Freddie’s well-heeled lobbyists. And so housing was increasingly financed by lenders insensitive to market risk.

Recently, as mortgage companies began to fail, the U.S. encouraged Fannie and Freddie (which already owned or guaranteed $5 trillion in mortgages) to buy still more mortgages. This aggravated the problem. Since the agencies’ capital was inadequate, they should have been reducing risk.

In a similar vein, federal regulators seized IndyMac, a Pasadena bank whose depositors had crowded the door demanding their money and which became the second-biggest bank failure ever. The head of the Federal Deposit Insurance Corporation immediately announced that IndyMac would stop foreclosing on mortgages. No doubt this was pleasing to California homeowners, as well as to the 55 congressmen and senators who represent them (and who help to oversee the F.D.I.C.). But it amounted to yet another giant socialization of risk and to a dubious precedent.

What if politically mindful regulators now lean on Freddie and Fannie to halt foreclosures? Exactly which losses are immunized and, just as important, who gets to decide? Similar questions have been raised by the Fed’s various actions to protect Bear Stearns and other investment banks and their collective creditors. In the space of several months, a wide swath of American finance has ceased to operate under normal rules.

Fixes are being introduced, and the next administration will very likely initiate its own reforms. The Fed has tightened mortgage rules; higher capital requirements are coming. Also, better accounting and disclosure rules would help investors to understand the often-complex assets that banks own.

But there is a difference between increasing transparency, with regard to risk-taking, and underwriting losses. The government should get out of the business of assuming risk — which hinders markets in a function they can handle better. With investors conditioned to look for rescues, it will not be easy to get the genie back in the bottle. A good first step would be to draw a bright line between Fannie and Freddie’s outstanding obligations, which total $1.5 trillion, and the borrowings they undertake in the future as their current paper matures. Their current debt is presumably socialized. But if the Treasury were to announce that new obligations were not protected, markets would gradually force the beleaguered twins to both raise more capital and shrink their asset bases. The U.S. might even consider splintering the companies, AT&T style, into pieces. The goal should be to ensure not that they never fail, but that for Fannie and Freddie and for other institutions, failure reacquires its proper status in a capitalist society: that of a tolerable event.

Sunday, July 27, 2008

WaMu given's lowest score under the "Safe & Sound" scale:

I still cannot figure out why any depositor over the FDIC insured limits would keep deposits at WaMu. You are making a loan (albeit fairly senior) to what is effectively a junk credit (BBB-) and getting paid basically 0% interest for it. The going rate for credit default swaps (CDS) on WaMu's debt was 19 points up-front - which is enormous - then a few points running. So, as a depositor, you get 0% but Wall Street is telling you that it is a toxic credit. Wall Street may be wrong, but I don't see how you are getting paid enough to take the risk as a depositor.

There is nothing that WaMu provides that differentiates them enough to put at risk any money as a large depositor. I still suspect a slow motion run-on-the-bank is underway (see post from two weeks ago). Would be an epic failute. From a societal perspective, I hope it doesn't happen but it sure would add some spice to an already tangy economic environment.'s Safe & (un)Sound rating on WaMu

Saturday, July 26, 2008

Seth Klarman on leadership

Value investing hero Seth Klarman of The Baupost Group gives his thoughts on leadership to HBS students in 2006:
Klarman Video

Sunday, July 20, 2008

Warren Buffett, Boone Pickens, and James Tisch all have substantial wind power investments

If huge financial commitments by those three folks don't tell you all you need to know about not just the viability, but the attractiveness of wind investments, then nothing will. Each of these three business and investing legends has invested billions of personal capital either directly or through their holding company conglomerates into wind power. That is not a subtle hint.

Today, billionaire investor James Tisch (Chairman of the Loews Corp. conglomerate), decided to take an even less subtle tact. He wrote an excellent oped that was published in today's Washington Post (included below) about how the development and adoption of alternative energy technologies is happening at lightning speed. Specifically he highlighted the attractive economics of wind and personal solar. Amazingly, this development and adoption is largely happening without incremental regulation, legislation or "incentive" taxation.

Can't you just picture the monkeys in Congress almost fretting about this fact? Worried that free market capitalism might actually solve three major platform issues without them signing their name to a legislative "solution"? What will they tell their constituents? I predict they will not stand for this. It undermines too much of what they have been espousing for the past several years. If this plays out as Tisch and I expect it to, the implications are that things like President W's refusal to sign the Kyoto Treaty may actually indicate that he did not cover the Earth in a man made global climate change sludge. I mean, are legislators really going to standby and allow three of their go-to policital hot button policy issues to be solved with them watching from the sidelines? I seriously doubt it. They've dreamt of regulatory and legislative "solutions" to these problems for years and now each of those issues may be stolen from them by the market? These three issues will not go quietly into the capitalistic night - not of the Nancy Pelosi's of the world have a say. She must worry about the potential removal of these three issues:
1) addressing the high cost of energy;
2) addressing our dependance on foreign oil; and
3) reducing our carbon footprint.

This has to be unbelievably frightening to the political monkeys. It is almost as if the market is saying to them, "just give us a fair legal framework to operate within, get out of our way, and we will take care of the rest." But that doesn't sate the average political ego. It does not sell in November either. Somehow they'll need to mess this up.

How can they mess it up? I'll propose three ways:
1) Interfering with the roll-out of alternatives like wind, hydro, nuclear, solar, or some other future technology by making regulatory hurdles unnecessarily burdensome.
2) Promoting one "alternative" over another. Don't promote corn ethanol, let the market promote it. If it is going to work, it will. Corn ethanol probably should fail and the unintended consequenses of its artificial elevation are that a) we are diverting precious agricultural resources from more useful efforts like, I don't know, growing food for things like eating and b) we are diverting financial and human intellectual resources from pursuing the best alternative energy efforts.
3) Disallowing competition. Let oil compete on a level playing field - the marginal barrel of oil is already incredibly expensive to extract. Let's not make it more expensive. Like it or not, we need oil and I personally prefer that we get it from "Big Oil" than from "Mother Russia". Let's not handicap our own industry as other nations subsidize their's. Outside of oil, let foreign suppliers of alternative energy or related technology present their solutions to the market. Brazilian ethanol may be a great risk diversifier for us as opposed to incremental Saudi oil.

All of these can be summed up as "don't interfere with the market mechanism by trying to create large incentives or disincentives for one 'solution' or another. This will create artificial distortions and likely prevent the best solution from rising to the top."

As I've been saying for years, the solution to high oil prices is high oil prices. I've said those will come as easy/cheap oil vanishes and the marginal barrel is in deeper water, tougher geology, or scarier places. And here we are, as forecast (Read Matt Simmons' Twilight in the Desert for an excellent primer).

Expensive oil creates an incredible incentive to look at alternatives and ramp up scale (e.g., reduce unit costs) of alternative energy technologies. Tisch describes this happening in wind right now. As noted, this will have the ancellary benefit of reducing carbon emmissions and decreasing our dependance on foreigh oil.

As alluded to above, can we please get rid of the imbosolic import tax on foreign ethanol? This is so stupid. We are "protecting" our domestic ethanol business, but corn ethanol is not a particularly productive solution. We may be the Saudi Arabia of wind, gas, and coal, but Brazil is the Saudi Arabia of sugar ethanol. Sugar ethanol is much more green than corn-based and Brazil has room to expand growing capacity without merely replacing other useful crops as corn in America has done (switchgrass, on the other hand, is another story...). Let's allow consumers, through their individual spending habits, to direct us toward the appropriate mix of these energy sources.

Anyway, here's Tisch's OpEd:

The Answer's in the Wind -- and Sun
By James Tisch
Updated: 07/20/2008

Bob Dylan said it best: "The answer is blowin' in the wind." While politicians and environmentalists have been busy arguing about how best to require that greenhouse gases be curtailed, the world around them has changed. The precipitous rise in oil and gas prices over the past year has made the debate on greenhouse gas emissions moot. The reduction in the output of those gases will move forward at warp speed, not because of rules, regulations and cap-and-trade decrees but because of free markets and economics.

Two factors are driving this sea change. First, the price of our traditional fuels -- oil, gas and coal -- has risen dramatically. Second, the silent and inexorable march of technology has dramatically reduced the costs of clean alternative energy sources such as wind turbines and photovoltaics, which converts sunlight into electricity. The result will be a dramatic reduction in the emission of greenhouse gases -- without politicians passing a single additional piece of legislation.

How have we come to this point? Blame it on oil prices and technology. The extraordinary increase in the price of hydrocarbons and coal has created a price umbrella under which competing technologies can flourish. Already, clean wind energy is increasing by leaps and bounds. In the past five years, more than 5 gigawatts of wind turbine capacity has been built in Texas alone; on days when the winds whistle along the plains, wind energy represents just under 10 percent of the electrical supply in the Lone Star State.

Today, wind energy is economic at about 7 cents per kilowatt hour, and that is without factoring in production tax credits. A few years ago, that cost was 15 to 20 cents. Compare the 7 cents for wind energy with the 12 cents per kilowatt hour required to build a gas-fired power plant, and you can see why there is a veritable land rush to harness wind energy.

Texas is not the only state where the gravitational pull of economics and markets is working. Across the country, the price of electricity has skyrocketed for homeowners and businesses. This steep increase is creating a wide opening for technologies such as photovoltaics. The cost of this technology has fallen over the past few decades and is about ready for prime time. That retail electricity prices are increasing by as much as 30 percent this year will only accelerate the arrival of the "liftoff" phase of photovoltaics. Also, retail electricity prices in New York may soon be headed to 30 cents per kilowatt hour. At those prices, an investment in a photovoltaic array on the rooftop of a house will pay for itself in fewer than 10 years, resulting in a greater than 10 percent return on one's capital cost. Compared to the sub-5 percent yield on municipal bonds, this return represents an extraordinary investment.

So, without a gavel coming down in a single additional legislative session, wind and the sun will become much bigger contributors to our national electricity mix. And an added benefit is that they generate absolutely no greenhouse gases.

One more fast-approaching major change will all but guarantee that curtailment of greenhouse gases becomes an issue of the past: the advent of the electric car. Improvements in battery technology mean that in the next five to 10 years, plug-in hybrid electric vehicles will finally be on our roads. Within the next two to three decades, the gasoline-fired internal combustion engine automobile will no longer be sold. Since gasoline accounts for more than a third of worldwide oil demand, the rise of plug-in hybrids represents a mega-change in terms of emissions.

Plug-in hybrids are dramatically cheaper to operate than today's cars. They will consume about 2 cents' worth of electricity to travel one mile, compared with the current 20- to 25-cent cost of driving a mile using gasoline. If consumers flock to them because of their lower operating costs, and they will, the resulting reduction in greenhouse gases will be a benefit of extraordinary proportion -- one that the Kyoto crowd thought could be achieved only through draconian regulation.

These changes will take place not only in the United States but worldwide. These technologies will be adopted simply because they are cheaper than their hydrocarbon-burning cousins. The old world of burning hydrocarbons to generate energy and power automobiles is on the way out because it is being priced out of the market. In the next few decades, it is possible that the only thing oil products will be used for is to power airplanes, heavy vehicles and ships. All that is required on the part of those wanting to reduce greenhouse gases is a little patience so these new technologies can be adopted by the market.

So there is a silver lining in the run-up of hydrocarbon prices. These elevated costs are causing a dramatic change in our energy and automobile mix that will result in significantly less greenhouse gas emissions in the next few decades. The change is already on the way based on today's technology, and it will only quicken with the technological advances that are sure to come. Without a doubt, the answer is blowin' in the wind.

The writer is chief executive of Loews Corp., which has interests in Diamond Offshore drilling; Boardwalk Pipelines, an interstate natural gas pipeline company; and HighMount Exploration and Production, which drills for natural gas.

Saturday, July 19, 2008

Where is the Outrage

Jim Grant brilliantly writes about the slow, boiling frog victory of populism. Paper money, socialized credit risk, socialized education, socialized home lending, socialized savings, socialized medicine, socialized banking, socialized deposit insurance, etc., ad nauseum. The slow creeping victory of populism, crystalized only in retrospect.

Why No Outrage? -

Tuesday, July 15, 2008

It isn't the GSEs we should worry's WaMu

Here's a copy of an email I sent tonight. Should be interesting to see what comes:


Sorry in advance. This is long. But I'm kind of worried.

With all of the hoopla surrounding Fred and Fan, I think a bigger story in the banking sphere is being ignored. To the extent the GSEs are taken into conservatorship (read: nationalized), really, not much will have changed. Some equity holders will get wiped out, but the institutions will keep on making mortgage loans. They are already quasi-governmental. In fact, as official arms of the gov't, the GSE's may become more aggressive as avoiding losses will likely be weighed against the perceived policy benefit of lubricating the housing transaction market (I say "perceived" for a reason, but that's a discussion for another day). While it will be scary to see the U.S. of A. put the GSE's $5 trillion of obligations on the federal balance sheet, in some sense, it is already there and has always been there. Plus, the assets are generally good assets so losses are unlikely to be much more than a short-term blip in the context of the Federal government's budget. I'm sure systemic fear would tick up a notch, but regular people won't be directly impacted. No depositors exist to be hurt and lenders will be made whole. However...

I saw tonight that WaMu has started pounding the table with assertions that it is "well-capitalized" in order to calm fears about its funding position (see here for WaMu's defense). This is not exactly what you want to hear from your bank. Personally, I prefer the sweet sound of silent confidence. There is a famous Wall Street saying that those that have to defend their financial reputations have already lost them.

For context, we just witnessed the nationalization of IndyMac (IMB) and the FDIC's resultant treatment of depositors that had over $100,000 in their IMB bank accounts (the FDIC has said officially it will not guarantee their excess over $100k). Given that backdrop, if I am a depositor in a hypothetical bank - let's call it Snashington Futual (SnaFu) - and I have over $100,000 on deposit, if SnaFu attempts - hope against hope - to convince me that everything is fine - for any reason whatsoever - I'm at the bank's front door at 9 a.m. (or whenever it is that banks open) and I am taking home cash. I am not bringing home a cashier's check. Not a wire transfer to be set-up for processing later in the day. I am certainly not bringing home mere "assurances". With a can of mace in tow, I am going into the bank and demanding my account balance be handed to me in the form of some f'ing cold hard cash and I'll happily risk the walk to my car. If SnaFu also happened to be incurring enormous losses on its asset base and had a stock price down 90% in the past 12 months, I might go 3G iPhone on them and camp out at my local branch overnight after maxing out my ATM withdrawal limit.

Unlike the GSE's that cannot have their funding source go negative because they do not rely on the goodwill of depositors, banks can and do. Particularly savings and loans which are overwhelmingly deposit and CD funded. Given Washington Mutual's market price, its own defensive pronouncements, its recently displayed need for capital, the run on and subsequent nationalization of IMB, the recent collapse of Bear Stearns, the general fear around highly levered financial institutions, the ongoing collapse in home prices, and the FDIC's handling of the IMB runoff, I think WaMu may be done. Perhaps within a week or two if the fear contagion spreads quickly, as it is apt to do. Remember, WaMu is already getting crushed on the asset side due to lax lending standards (e.g., defaulting mortgages), if this spreads to the liability side (i.e., deposits) the pinch from both directions may be too great to bear.

Predicting how others will react to news and circumstances is incredibly difficult and I'm probably going to be wrong. However...

In the past twelve months, WaMu's stock price has declined from $43 per share to $3.23 at today's close, a 92% decline. This is starting to receive national attention and I suspect their assertion of a sound capital position will add to the volume of press. I also suspect the typical depositor with over $100,000 in their bank account happens to be above average in their market awareness quotient. Looking back at IMB's $19 billion of deposits, about $1 billion were uninsured (too big or not qualifying for other reasons). That that ratio is after the 11 day run on IMB that began with Sen. Chuck Schumer's (D - NY) idiotic remarks two weeks ago during which time $1.3 billion was withdrawn (article about Schumer's remarks). I feel confident that a disproportionate number of withdrawals during the run on IMB were by large depositors given they are the most aware and have the strongest incentive to bail. So, the pre-run on the bank ratio was probably something like 15:1 insured to uninsured deposits. It is worth noting that in a mere 11 days, more than 5% of IMB's entire deposit base was withdrawn. No modern bank can withstand that. It is worth noting that IndyMac does not garner the media attention that WaMu garners yet word still got around that it was on the brink and the vaults were emptied lickity split.

Much like IndyMac, which is HQ'd in SoCal, Seattle-based WaMu has a huge California presence and both specialize in Alt-A loans. WaMu will be heavily mentioned in the news tonight and in the papers tomorrow a.m. as it is the largest S&L in the United States (IMB was #8 on the list) and WaMu's stock was down another 35% Monday the 15th (it nearly kissed $3.00 at one point reaching $3.03 before closing at $3.23). In conjunction with the news surrounding IMB's nationalization, I'm predicting WaMu's deposits begin their outflow shortly, if they have not already. Imagine another day like today in WaMu's stock - we'd have a stock price looking something like "$1.50" and the media would be all over it. If you were a depositor, why would you not withdrawal? What is your upside to staying? Do you really want WaMu credit risk? This is like Lehman on the weekend after Bear's debacle but before the Fed stepped in. Who wants that risk? And for most depositors, we are talking about their livelihood. What is your upside? I know WaMu's "stores" are brightly lit, chicly furnished, and in convenient locations with good customer service, but I suspect the family with a $500k nest egg is going to say, "I am not willing to pay $400k for customer service."

This sort of thing feeds on itself and I'm not sure there is enough capital that can move quickly to plug the hole in the dam short of the Federal government. If the $7.2 billion that TPG's consortium does not convince people of WaMu's soundness, how much money will it take? Why would depositors ever be convinced to stay once the fear has set in? Plus, TPG's deal includes a ratchet that makes any new capital raises incrementally more difficult to pull off given the dilution and there are substantial regulatory barriers to non-bank holding companies buying banks. I hope against hope it does not play out like this, but I certainly would have brown undies if I were in TPG's place.

So, what happens if WaMu goes down? Let's do some quick, frightening math:

IndyMac: $32B in assets, $4-8 billion in announced expected losses by the FDIC. Prior to the IMB nationalization, the FDIC had a $53 billion deposit insurance fund which will likely be at least 10% lower after the IMB clean-up ($4-8 billion lower, in fact).

WaMu's asset base is around $320 billion. So, almost exactly 10x IMB. If somehow WM went under, and if the FDIC pronounced a similar ratio of loss estimates, the FDIC's insurance fund would effectively be wiped out. They'd be wiped out and my suspicion is the bank-bankruptcy train would just be leaving the station. The next bk would truly be on the tax payer's dime. Not saying it (FDIC takeover and/or similar loss ratios) is definitely going to happen, but I put the odds at high enough that we should be more than a little worried. Yet nobody is talking about this. I suppose it is uncouth for a media outlet to speculate on runs on banks, since they may accidentally create their own news, but this is a real problem. And I can say with confidence the FDIC is not in a position to run a bank like WaMu. I don't care how many people the FDIC has staffed up with: first off, they would be taking over an enormous institution with broad footprint and second off, on average, if they were great bank executives, they'd be working for a bank and not the FDIC.

Further, while the FDIC's funding gap would probably be made whole by tax payers (go team!), if I'm a depositor at a somewhat fragile institution (basically any regional bank with heavy southeast or southwest exposure), even -a depositor under $100k, I am probably going to the bank, cashing out, taking my bag of cash and aforementioned can of mace across the street and either getting in my car to go home and stuff the cash under a mattress or, under a more optimistic scenario, I'm going to a bigger seemingly safer institution like Wells Fargo or B of A and opening an account there. But are they really safe? Fear begets fear. As FDR said in the midst of the greatest season of bank runs in recorded history, "all we have to fear, is fear itself." Ugh.

All of this is a wee bit Chicken Little, I readily admit. But I also think the probability skew is uncomfortably high. And, if you are a lender that is "all-in" on one loan (e.g., a bank account holder), all of the sudden that 0.125% interest rate on your "free" checking account does not seem so important. Sometimes it is bed time and the hour has come for you to take your toys and go home, take a Rumplestiltskin style nap, and assess the situation on the other side.

Others that would die if WaMu goes down (randomly selected by searching for who already are the walking dead):
- Downey Financial (DSL - SoCal based and also defending its capital position - $12.6B in assets)
- BankUnited Financial (BKUNA - SoFlorida and defending its capital position - $14B in assets)
- Sterling Financial (STSA - Washington State based - $13B in assets)
See here for other S&Ls that are laggards in P/B ratio which will pretty much tell you who the market thinks is toast:
see here for P/B laggards in the S&L industry
[it is also worth noting that Lehman, which is unrelated to this in so many ways but connected by mindshare, may be lit on fire under this scenario. Lehman loses the more fear increases. Further, anyone that is levered and holding a substantial Alt-A book might be in super, duper trouble since that is WaMu and IndyMac's bread and butter...ING anyone?]

In related news, socialism received yet another boost from our incumbent government as FDIC Chairwoman Sheila Bair announced IndyMac will halt all foreclosures on portfolio'd mortgages and aggressively seek loan-modifications. I think of this as socialism squared. I'm sure IMB's uninsured depositors are appreciative!...or maybe not so much. Don't worry, it's not your money Sheila!

Before I get into the implications on our portfolio of a potential WaMu collapse, it's worth noting that crises in financial related businesses are so much more damning than other kinds of companies. When a telecom company goes under, it sucks for the shareholders, employees, and some of the lenders, but its impact is generally limited in scope and folks can see it coming. Plus, the assets of the business don't generally disappear, they either are acquired or the company re-orgs and comes out with a cleaned up balance sheet. But levered financials with deposit funded businesses are so fragile: the collapses happen all of a sudden, they impact tons of small folks right in their wallet, and they spread a paralyzing fear. This fear is rational because banks and savings & loans disproportionately owe their existence to trust - the trust of depositors. And collapse impairs that trust for a long time.

So, what does all this mean for us? First off, it has not happened and it is quite possible no big banks go into conservatorship. I am definitely spreading fear and perhaps it is not justified. But, as I noted above, all of these institutions are already getting absolutely crushed on the asset side of their balance sheet. If the liability side starts demanding repayment, watch out below. Implications: in general, forced deleveraging is deflationary. This is because the money multiplier begins working in reverse and losses are magnified 12x or so in credit contraction via the bank capitalization structure. However, our government seems to have indicated one thing if nothing else. That one thing is a refusal to allow de-leveraging and the concomitant potential for deflation to run their course. Instead, they have decided to socialize credit risk, avoid deleveraging and supplement the holes created by real losses with newly minted money. If the government chooses to address a real banking crisis (and, to be clear, to date we have not had a banking crisis, we have merely had a credit contraction - see 1932 or even 1989 for a banking crisis) by cranking up Uncle Ben's Crazy Helicopter and dropping money from the sky, we may light off the great inflation of our times simultaneous to a massive economic slowdown. Thus, the pain that banks feel on both sides of their balance sheet will spread and consumers will get a similar pinch at home.

Ways to protect yourself: gold, TIPS, curve steepeners, consumer staples with low capex and strong pricing power, Singaporean dollars, currencies of growing commodity-strong economies (Russia, Brazil, Canada (the Looney!), puts on anything equity related, continued shorting of financials (though that game is getting dangerous so I'd stay focused on marginal regional players). I'm sure other folks have ideas and my brain is drained for the night...

Again, my scare scenario has not happened but the question is do we take steps prior to the collapse, do we wait until after it becomes obvious a collapse will happen, or do we just sit tight and hope it does not happen?

On that cheery note, off to bed.