Betting on Banks

Warren Buffett made a big investment in Bank of America a couple weeks ago. The PE based on estimates of next year's earnings is about 4, which suggests it is really cheap. Unfortunately, there's a catch.

Our government is going after the banks, suing them for losses on loans guaranteed by Fannie and Freddie. As Dick Bove notes, this would be the tip of the iceberg:

The price tag is unlimited. Basically, we can look at Fannie Mae and Freddie Mac and say they've lost $33 billion, supposedly, as a result of buying these bad mortgages, and therefore, those losses should be put back to the banking system. But in essence, if we establish the precedent that anyone can sue a bank if they get a mortgage that doesn't work out, and there were $5 trillion of mortgages that were securitized through this Fannie-Freddie system over the past number of years. I have no idea how many people would sue, nor how much the courts are willing to give back to these companies and take away from the banks. It's a very, very negative development.

So, if the government wins this case, it would establish a fact that other investors could use, and given the size of the mortgage market, basically wipe the banks out. Meanwhile, Obama has been castigating 'fat cat bankers' for not lending more. Bove thinks banks are a good buy because the government will realize it is making a mistake: ruining the banking sector would not help the economy, we don't have enough money to recapitalize it after giving it to the trial lawyers.

The government is basically behaving like a child, wanting inconsistent things. That's understandible, because the government is not a unified whole, rather, a collective with many parochial interests. The rumored call for selective stimulus through targeted tax breaks for 'innovative' businesses, and the constant demand for closing corporate loopholes, is inconsistent. Today's loophole is yesterday's targeted tax break. So is the idea that for labor, temporarily reducing payroll taxes is a good idea, but that same administration has pushed for increasing the minimum wage.

Bove is betting that the FHA will have the wisdom to drop the lawsuit because winning would be a tragedy for the economy, and I bet Buffett also has this kind of faith. It's an interesting gamble.

Personally, I think the quicker bad ideas fail the better. Obamacare is really poisonous because it kicks in slowly and front loads revenues, so by the time everyone notices it is a bad idea and very expensive (say 2014), it will be impossible to prove what provisions and who is at fault (the new President, or Congress, will be to blame). Let the FHA win its lawsuit asap, crash the economy, and then our legislators may understand that without a vibrant business sector, they have no taxes to distribute.