Nowhere Man

This past weekend, Barron's published two articles pertaining to the government's involvement in the banks. One article discussed the advantage of buying non-cumulative preferreds instead of common equity as a speculation for possible gains should the bank in question recover from the current financial crisis. That part of the article makes sense. With some of these non-cumulative preferreds selling at between 35 and 50 cents on the dollar and yields near or above 20%, non-cumulative preferreds may be a viable alternative to common equity. The article drifts off base after that.

The article repeats the Bill Gross mantra that if the government owns preferred shares, investors are protected by investing along side the government. With the government investing at the preferred level because it had to, to increase banks' Tier-1 capital (not because it wanted to) and giving itself a cumulative feature, having the government along side you is like going into business with the mob assuming that the local don will treat you as he treats himself when the operation goes south. When one invests at the preferred stock level, one is a part owner of the company and not a creditor. When things get tough, creditors get paid (hopefully) at the expense of owner distributions. This is not to say that preferred stock dividends will not be paid, but why take the risk? At least get to the trust preferred level to become a creditor. Hope that the government will take care of you because it owns preferreds (which the dividend is a drop in the bucket when considering government dollars) is not a strategy.

The other article discussed how further government assistance for banks to could favor depositors over investors. The article suggests that troubled banks could be restructured in a way in which investors, even bond investors are not made whole. The funny thing is, only one person mentioned this article. After all, this is a negative article. This is a case of seeing what one wants to see.

This article may not be any more correct than the positive article about preferreds, nut it may not be any more incorrect. My point is that this is the most severe financial crisis since the 1930s. The implications of government and private sector policies and actions should not be taken lightly.

GM and Chrysler could be subject to a government restructuring. If that ends up being the case it is very possible that the government forces investors, even senior bond investors, to accept less than 100 cents on the dollar. Bloomberg News reported today that government lawyers are working to ensure that the government has the top claim with regard to compensation in a restructuring of the auto makers. Invest along side the government? Right.

The Associated Press published an article about the latest bank rescue scheme and the plan to purchase bad assets from the banks which includes opinions and comments from various market participants. They comments are not dissimilar from what I have written previously. Take a gander:


"The first loss has got to be the government's," said Wall Street veteran Muriel Siebert, who runs the brokerage Muriel Siebert & Co. "Maybe the first 25 percent of losses. We don't know what's in some of those bonds."





"Billionaire Wilbur Ross, who runs the private equity firm WL Ross & Co., said investors want to know how much risk the government will accept if the investments go sour, and how much money the government is willing to put up — likely in the way of low-interest loans."





"And any sort of financing is something I would be interested in," said Jeffrey Gundlach, chief investment officer of Los Angeles-based money management firm The TCW Group. "There are distressed assets that I would like to buy now but I can hardly get anyone to lend me any money in the current environment."





"I want to see the incentives and the restrictions," said Jacob Benaroya, managing partner of New Jersey-based Biltmore Capital Group, a hedge fund that's buying up to $100 million in mortgage debt per year. For example, he said, he's unlikely to be interested in buying loans that must be held for 30 years.





"Investors want to know more about what those guarantees will be. Stephen L. Nesbitt, whose firm Cliffwater LLC advises clients considering alternative investments, said people want returns of about 20 percent before they will buy into really risky, distressed debt."

"They need help from the government to get there," Nesbitt said. "Either by increasing the return or decreasing the risk."



"Why would anyone want to buy these assets at inflated prices?" said Bill Fleckenstein, a Seattle-based hedge fund manager. "There's this argument that the banks can't sell at market prices because the market price is depressed. Well, that's what the market price is.""





"Lynn Tilton of the private equity firm Patriarch Partners said she wants to know what the government will consider a "bad asset" under this deal. There has to be some effort to find a real value, she said."



There you have it. Investors may consider buying troubled assets, if the government limits losses, provides cheap financing and they want to buy at fire sale prices. Simple eh? Godspeed Mr. Geithner.