Friday, September 26, 2008

The Shortlist Shortens Again as JP Morgan Buys Washington Mutual

Last week I offered a shortlist of individuals and corporations whose wealth and power made them ideally suited to play roles in turning around the US banking system. On my list were Wells Fargo, JP Morgan, Warren Buffett, WalMart, and General Electric. I identified each participant because, in my judgment, their presence would be a vote of confidence to an increasingly fragile banking system that was having trouble raising capital. I reported on Wednesday that Warren Buffett had moved off the shortlist first by investing $5 billion in Goldman Sachs (GS) preferred stock, with warrants to purchase another $5 billion of common stocks. I fully expect more activity from Mr. Buffett and Goldman Sachs. Goldman has registered themselves as a bank holding company, which would mean they could eventually take deposits. Since this is a very low cost method of funding their operations, there is a good chance they are going to want to buy a good sized bank to enter this business. The second departee from the list is JP Morgan (JPM). JPM bought Washington Mutual after the FDIC closed the bank Thursday evening. You will recall that I thought Wells Fargo was the likely suitor for Washington Mutual, and that JPM was a good match for National City. It is now clear that JPM chose to go after WM to gain a West Coast presence. I still expect Wells Fargo (WFC) to make a major acquisition within the next few weeks. With GE deciding to strengthen the financial position of their GE Credit division, they become less likely to be a buyer of banking assets. Walmart would require a change in the laws to become a player. They have not said anything publicly about such a move, but they have made it clear in the past that they wanted to be in the banking business, and in light of the current crisis, their strong balance sheet would be a welcome addition as a possible acquirer. As I write this, the wire services are saying that an announcement about a plan to save the banks will be issued before the markets open on Monday. Politics has entered the mix which makes a deal more difficult, but I believe politicians on both sides of the aisle realize that without some sort of plan more banks will fail in the coming weeks, wiping out hundreds of billions of peoples' income producing assets. Perhaps as you read this, you think that is just what should happen. After all risk is risk, right? Here's the problem: bank's stocks have long been seen as so-called widows and orphan's stocks. Banks are owned by the same people who own utilities and telephone companies. They count on the income to live. The Washington Mutual take-over model undertaken by JP Morgan brought safety to depositors of the institution, but probably wiped out all equity and debt holders. Thus, JP Morgan gains a valuable assets, but it was done on the backs of conservative income investors as well as the bigwigs. Washington Mutual was aggressive and has paid the ultimate price. But had a rescue plan been in place like the one that Treasury Secretary Paulson proposed, it may have been possible for WaMu to have survived and given an opportunity for the shareholders and bondholders to have gradually made a comeback as new capital was made available to the bank. I have heard a lot of high sounding rhetoric about moral hazard and not bailing out the bank bigwigs. That misses the point that bank stocks are not like tech stocks. These bank stocks that everyone seems so anxious to let go down the tubes have been in business for generations, and many investors have such low bases in the stocks that they have been reluctant to sell. The tech craze largely affected younger and savvier investors. If banks are left to dangle in the wind and then fail, many innocent older people are going to be hurt. We tough nosed investors can say all we want about letting the bigwigs get their comeuppance, but before you drive your Hummer into that gathering of bigwig bankers on the street out in front of their building, remember, you will also be plowing through Aunt Minnie, grandmother, cousin Fred, and the endowment plan of the church on the corner. If this rescue plan turns into a lynch mob of bigwigs, we will be returning an evil for an evil, and the only winners will be the bigwigs from that other bank in that other city. The small investors' assets will die at the exact moment as does the bigwig's.