The New Bailout Meme: Banks Will Earn Their Way Out of this Mess
Posted on March 12, 2009
In every boom and bust, there are competing memes, which catch investors attention and drive prices to extremes.
During the current financial crisis, the prevailing meme, at least over the last few months, has been that the large US financial institutions are insolvent. This meme is founded on a balance sheet perspective. Since it has been the accepted the meme, prices of financials have plummeted.
Recently, many famous investors and CEO’s, including Warren Buffett (who is biased to the extent that he has major investments in financial institutions), have been trying to create a new meme, based on bank’s income. The meme is that: Banks can earn their way out of this mess because of their basic “spread” lending business and their “princely” lending spreads, as Buffett calls it. Incidentally, I put forward this same exact theory (wrongly I might now add) nearly six months ago when the crisis first started, in this post: Ignore the Bailout Drama.
If this new “Earn Their Way Out” meme takes hold, and the focus turns away from banks balance sheet, a viewpoint which would be strengthened by some sort of repeal of Mark-to-Market, we will almost definitely see a continued rally in stocks for quite some time, with only minor sell-offs.
Whether or not this meme is correct or not (note: it is incorrect), is not really the issue. If enough respected people repeat it, and focus attention away from bank balance sheets, stocks will continue to rise, especially if the new meme gives people confidence in the banking system again.
But, don’t hold out much hope for a sustained rally as the new meme, despite backing by people like Buffett, is completely false. As I’ve mentioned in the past, the true profits at banks have nothing to do with lending off of princely spreads. Big banks, which are the ones we’re worried about, make their money off of securitizations, trading of derivatives (i.e. imaginary securities), and ponzi-like financial funding structures. The princely spread business is old-fashioned banking and could never support the big banks in any meaningful way. Try to find a banker getting a $100 million bonus because of princely lending spreads.
To the extent that securitizations, trading, and ponzi-finance are the profit centers of our big financial institutions, the balance sheet will always be more important than the income statement and repealing of mark-to-market is ridiculous. Essentially, large financial institutions, whether rightly or wrongly, are simply gigantic hedge funds and as such they must be treated as such, both from an accounting and valuation perspective. One wonders what would happen if it became completely legal for hedge funds to determine their income based on what the fund says the assets are worth, rather than what the market says they are worth? Would one be able to then avoid a margin call by simply proving that a certain stock should theoretically be trading at a much higher price, even though it is now at a much lower price?
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[…] The New Bailout Meme: Banks Will Earn Their Way Out of this Mess …To the extent that securitizations and trading are the profit centers of our big financial institutions, the balance sheet will always be more important than the income statement and repealing of mark-to-market is ridiculous. … read more… […]