The Bank of America Deal

This morning, Bank of America announced that they had struck a deal with Warren Buffett, a deal that is effectively a $5 billion loan to the bank from Berkshire. Of course this was spun as  a great thing for the financials and for BAC in particular, and a ‘vote of confidence’ in the bank and the US economy on the whole.

To most skeptics, this has been seen as an admission of  trouble by BAC. Rumors had been rampant that the bank is under capitalized, and given the fact that it is knee deep in the housing sector it is very, very likely that it is insolvent. Surely enough, it has proven to be merely an opportunity to put out new shorts, as the stock sold off all day once the market opened. The initial announcement caused a 22% spike, by the end of trading it was up 9.5%. Perspective from Nicholas Santiago via Naked Capitalism:

Here are a few key reasons that tell us this deal is forecasting problems ahead.

1. It was just a few day’s ago that Bank of America stated that they did not need any capital, now we know that was not true. The second largest bank in the United States needed capital and they needed it bad. We can only wonder how long this deal will help to lift the market. Just look at 2008, this could be a repeat of things to come.

2. The Warren Buffett investment in BAC stock also tells us that the European banks are not the only banks in serious trouble. The leading banks in the United States are in serious trouble as well. If there is one cockroach there is usually a million.

3. Warren Buffett has made a career of investing in troubled companies for the sake of the economy. The last time he made an investment such as this one was back in 2008 with Goldman Sachs Group Inc.(NYSE:GS). It is important to remember that Goldman Sachs was bailed out by the tax payer in what was called the TARP program. Buffett knows that  the U.S. taxpayer will bail him out if he is wrong and Bank of America stock does go belly up.

Point 3 is of particular note to me, as he was quoted today as saying that Bank of America is ‘certain to be around’ for a long time. Given his recent meeting with the President, the more skeptical among us might conclude that Buffett got some sort of ‘assurance’ that BAC is still in fact TBTF and will be treated as such should things get a bit sticky.

As point 3 also mentions, the Goldman Sachs deal in 2008 is the same vein as this one, an investment in a troubled financial name which ultimately needed taxpayer help to survive. Far from these investments being a vote of confidence in America, they are attempts to preserve the economic structure that Buffett directly profits from. His investments in names such as American Express, Mastercard, Wells Fargo and other financial names means that he has a huge interest in preserving the current structure of the US economy, namely the debt driven consumer spending model. In my view that model is well and truly decimated, and as such most of the financial names at the heart of that model are set for tough times. Backstopping that model is backstopping Berkshire and several of the other financial tycoons that have come to prominence over the last few decades. Which is why they all perceive the actions undertaken in the wake of the Financial Crisis as mandatory. The fact that it was bad economics means little.


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