Stress Test Done, Crisis Over; Buffett Wrong, Kass Right.

Fed Sees Up to $599 Billion in Bank Losses
Worst-Case Capital Shortfall of $75 Billion at 10 Banks Is Less Than Many Feared;
Some Shares Rise on Hopes Crisis is Easing

—The Wall Street Journal, May 8, 2009

Three weeks ago, in “Stress Test On, Crisis Over,” we here at NotMakingThisUp argued that the fact the government was finally getting around to “stress-testing” the health of the nation’s largest banks, at a time when banking fundamentals were starting to improve, meant that the crisis itself was over.

We summed up our admittedly cynical, but grounded-in-30-years-of-watching-The-Market view this way:

Putting it into a formula, we derive the following:
Improving Fundamental Outlook + Severe Government Reaction = Crisis Over.
And we think you can take that to the bank.

—NotMakingThisUp, April 17, 2009

Today, with the results of the Federal stress test in, and many financial stocks using the occasion to continue their recent rally, we think a greater and far more important voice than our tiny virtual speaker-phone could ever be—The Market itself—has made itself heard.

And we think The Market is saying, “Crisis over.”

Now, by what perverse logic has this come to pass, you may wonder? How, as Don Corleone would have asked, did things get so far—that bank stocks would actually rally on headlines that Federal authorities fear up to $599 billion in bank losses and a capital shortfall of $75 billion at the top 19 banks?

Simple.

The Feds gave it their worst—for the moment, anyway—and that worst-case scenario proved to be not, as most investors had previously feared, widespread bank nationalization and more bank failures, but merely a new round of capital-raising that most of the banks in question appear capable of persuading The Market to handle.

In brief, the government has shown The Market its very worst case, and with that in mind, investors can now evaluate financial stocks they might want to own, without the sort of dreadful gnawing that some kind of unquantifiable black hole still lurks in the wings.

Which brings us to the headline of today’s piece.

What, exactly, did Warren Buffett get wrong, and Doug Kass get right?

Well, Buffett himself spoke out on the stress-test just last weekend at the Berkshire Hathaway annual meeting—Buffett’s “Woodstock for Capitalists,” which we attended with more than a rooting interest in the questions being asked of the “Oracle of Omaha.”

(See “What They Want to Know: Our Top Ten List for Warren Buffett ” from April 23, 2009 for details on those questions, and stay tuned here: we’ll have a follow-up on the meeting, and the questions that were asked, next week. But by way of a preview, Buffett was asked one of our Top Ten questions, and by Aznaur Midov, a student from San Francisco State University’s Financial Analysis & Management Education group no less. Aznaur made the pilgrimage to Omaha with his fine classmates barely a month after we all met on their home turf for an intense, intelligent, and fun discussion of Buffett, Berkshire, and hedge funds.)

And what Buffett said, when discussing Wells Fargo—one of Berkshire’s largest stock holdings—was this:

“Wells Fargo is gonna be a lot better off—unless they have to issue a lot of shares, which they shouldn’t…”

Yet just this morning Wells Fargo issued 341 million shares, which is “a lot” in anyone’s book. In fact, it’s more than the 290 million shares that Berkshire Hathaway currently owns.

Buffettologists will, I know, complain that Wells Fargo really shouldn’t have been required to issue those shares, so Buffett wasn’t really “wrong.”

They’ll say today’s 341 million share offering was done only in response to the Fed’s stress test, and besides don’t you know Buffett has compounded Berkshire at 20% a year for 44 years and who are you to point out something the Oracle got wrong, and when did you become the expert and yadda yadda yadda…

But the fact is, Wells was required to issue “a lot” of shares less than a week after those words were spoken.

Besides, there’s no criticism implied in making the point that Buffett got it wrong. For one thing, we’ve never been on the short side of Wells Fargo, for the simple reason that we remember too well that the same arguments now being made against Wells Fargo were being made back in 1990, when smart people told us how stupid Buffett was about Wells Fargo, and that Wells was up to its eyeballs in bad loans, and how could Buffett not realize Wells Fargo was going tapioca, and yadda yadda yadda…

…not long before the U.S. housing market, and Wells Fargo stock, began a very long rise up and to the right, to the benefit of Buffett and Berkshire shareholders.

Furthermore, the reason Buffett made the comment in the first place was that he’d been telling the story of how he told a business class from the University of Chicago, on the day Wells Fargo hit $9 a share, that, if he could, he would have put his “entire net worth” in the stock at that price.

Not a bad call at all. In fact, a great one.

(Having spoken to the very same University of Chicago Booth School of Business group just prior to their visit to Omaha, we give a shout-out to Chris Knapp, Jennifer Yang and the rest of that fine crew: they asked some of the best questions we’ve gotten about Buffett and Berkshire Hathaway, and it doesn’t surprise us a bit the Oracle mentioned their visit.)

Finally, the Wells offering makes our “Crisis Over” point better than anything we could write: the deal was priced at $22 and the stock is currently north of $25. A market that doesn’t blink while swallowing $7.5 billion of stock is a market that’s hungry for more.

Now what, you might be wondering, did Doug Kass get “right”?

For starters, in Doug’s “20 Surprises for 2009,” which we highlighted late last December on these virtual pages, Surprise #2 was this:

Housing stabilizes sooner than expected.

That nugget—widely derided at the time—looks like it is coming to pass, with tremendous implications for all kinds of businesses.

But second, and more importantly, we recall seeing Doug on “The Kudlow Report” during the dark days of late February/early March, when the S&P 500 was on its way to a negative 25% start to the New Year, on top of last year’s performance-killing negative 37%, and not many people wanted to hear from optimists.

But Douggie was optimistic. And he said so.

His exact words, as we recall them, were an echo of Buffett’s most famous comment on The Market—indeed, the best and most unequivocal market call ever printed—“Now is the time to invest and get rich,” which Forbes published at the market lows in the dark days of late 1974.

Just as ridiculous as those words might have seemed when Buffett spoke them in 1974, they seemed ridiculous the night Doug Kass spoke them, before he went on to elucidate why he believed them true.

And in light of all that has happened since those dark days of early March, 2009, our virtual hat goes off to Doug Kass, for getting a big thing very very right.

For what it’s worth, that same hat goes off to Warren Buffett and Charlie Munger, too, for taking the time to talk to shareholders for five hours last weekend. It’s something no company Chairman or Vice-Chairman has ever made a regular part of his or her annual meeting, and likely ever will.

And it’s something we think not only every investor, but every CEO, CFO and board director should experience at least once in their careers.

We’ll have more on our first impressions from Omaha come Monday.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
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