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This morning I noticed a story on Yahoo about six difficult home loan workouts. Is it just me or do details in some of these stories not really add up unless you assume facts, which, had they actually been included, would make you feel less sorry for these people? Is it just me or are some of these stories just outright ridiculous when you turn on your brain?

Sue Wright’s story about a failed loan workout in Las Vegas mentions that they’ve lived in their home for 15 years, but are well underwater on the mortgage. Unless you assume that they lived there but didn’t own the house until maybe 2-3 years ago, this doesn’t make sense. I don’t think your average house purchased 15 years ago in Vegas lost value compared to then. Interest only loans were also not available back then, so the Wright’s should have had some principal paydown by now, at least in the 20% area or so. So if you assume that they did actually own the property all this time, then what probably happened is that they did one or more cash out refi’s as house prices were going to the moon. Unless they used all this cash to pay for unexpected medical emergencies, should you feel sorry for these people?

Chancey’s story is similar. Apparently she lived in her home for 23 years, but because of family health problems, divorce, and economic factors all “conspiring” against her, she’s never been able to substantially pay down the loan. Sorry, but this also only works if you assume cash out refi’s along the way. Had she not taken money out of the house, it’d now be getting close to being paid off after 23 years.

Next comes Richard, the retired high-steel construction man. His story absolutely takes the cake. All of a sudden, completely unexpected and surely just because of greedy bankers, his adjustable mortgage reset and he was facing higher payments. He actually does have $370,000 equity in that duplex (not to mention that he owns a $500,000 second home in Florida), but what does he do once he runs into cash flows problems? He doesn’t consider taking responsibility for being overly levered. No, instead he tries to make the bank take the loss, so that he can hang on to his wealth currently tied up. Wow, are we really expected to feel sorry for this man? I didn’t even mention that his spouse is a retired attorney who owns five cottages. Are the people who put together these stories effing kidding us?!

Ron Nash, our motivational speaker in the next story, decides to walk out on his upside down mortgage. I mean, why not? Why actually honor contractual obligations if it doesn’t make sense to you anymore? After all, contracts are only good for as long as they’re beneficial to you, or not? If they stop serving you, just ignore them and let the bank take the loss. Would you hire such a guy for your next motivational event? Once again, are we supposed to be angry at his bank for not throwing $240,000 his way when he asked for a reduction in principal? Dude, you bought too much house on a highly fluctuating income. Dude, you suck at personal finance. Don’t make others pay for your problems.

In our sixth and final story, Ken Mobley needed some urgent cash for the holidays, so he calls his bank and asks for a two-month postponement of his mortgage payments. Eh…where I come from spending on holidays is still discretionary, not mandatory or contractual. Why again would you get mad at your bank for not agreeing to this? You’re essentially not honoring your obligations to buy some Christmas gifts. What a joke.

It’s just so sad how our media continually spins their “greedy bankers, poor borrowers” stories. Over and over again, on TV, online, and probably in print as well. Where are the stories that ask for sacrifice and personal responsibility on behalf of everybody? Both Wall and Main Street caused and are actively contributing to this downturn. It doesn’t even seem to occur to the people featured in the stories on Yahoo that maybe some of their troubles are of their own making. Yet all they do is complain about how the bank didn’t streamline the process of throwing money their way.

Finally another weekend is upon us. And boy, it didn’t come soon enough. What a terrible week it has been. Almost every day there was more carnage in the markets, particular the financial sector. Will it ever end?

As a serene investor we have to acknowledge the fact that we don’t know. But neither does anyone else. Historically these bad times did end eventually, and I happen to think that it will be the same with this crisis. Nothing about our current problems strikes me as particular unsolvable. We just have to keep our fingers crossed and hope for the best.

A good way to wind down in such stressful times is to listen to chill-out music. Close your eyes, let your mind wander and visualize a better tomorrow. No harm in that, is there, ay? And to help you relax I’ve included a very nice song from my favorite German act “Schiller” . Enjoy:

Watch out, S&P and Moody’s love to downgrade stocks on Friday after close. They might not like how GE insists on paying out the dividend. To me the current depressed stock price already more than reflects a downgrade, but in this horrible market nothing ever seems to be priced in.

Update: so obviously there was no downgrade. I have no opinion whether a ratings cut would be justified or not; I’ll let others speculate what constitutes a proper AAA rating and what doesn’t. But as we’re talking about ratings, to me Moody’s and S&P should be shut down and replaced by government run, non-profit rating agencies. The amount of damages these two institutions have caused is completely beyond comprehension. Had they done a proper job, the global fallout of the housing bubble would have been so much smaller it’s not even funny.

If you want a better, more acurate rating than what these clowns can provide, just program a short macro that rates a security based on it’s current price / marketcap / OAS. Much more timely.

I dedicate this song to Mr. John Thain. He had a hard day today. Leave him alone.

Poor Aflac got it on the chin today: down almost 37 %. Apparently the big financial troubles in little England cause anxiety as they relate to Aflac’s holdings of hybrid securities. I can’t say much about the company or it’s troubles, as I have never really looked at it in detail.

But I can say something in general about stocks that are (or should I say were) spared the worst of a general bear market. There are always stocks that hold up much better than their competitors due to perceived differences in management or product quality or whatnot. In this bear, two in particular had caught my eye: Aflac and Wells Fargo.

Over the past few months I’ve looked at the insurance sector more than once. One company always stood out: Aflac. While all their competition was getting crushed and was generally selling at less than Book Value, Aflac was still trading at 2-4 times of that. Same goes for Wells Fargo in the banking sector. For whatever reason they were still trading at two times Book Value until very recently, even though pretty much every competitor was already well below that, even the better ones such as JP Morgan.

It doesn’t really matter why the market perceived these two companies to be superior. While Aflac may really be better than the everyone else (I just don’t know), it’s completely beyond me why Wells Fargo held up as well as it did, especially after acquiring Wachovia last year.

Usually what happens, especially towards the end of a bear market, is that all the “survivors” will also be beat up. Mostly it’s some analyst who wants to make a name for himself and homes in on whoever is not on the ropes yet. At this point in the business cycle emotions are so fragile that people don’t even care questioning what they read anymore, they just sell. And even more so when it comes to the one or two holdings in their portfolios that have held up well so far. “Of course”, they’ll say, “I should have known. Nobody will be spared. I was foolish for thinking this one was different. Quick, let’s get out”.

Lesson: if you happen to own a company that is valued much higher than their competition, seriously consider about buying protection, such as put options. It doesn’t matter how long they’ve survived without being impaired. Markets are not efficient in the short run, especially not when emotions run wild. It only takes a few days and the company is cut in half or more, and you quickly lose all your outperformance. If you don’t like buying expensive protection, consider swapping out your stock for a sector index ETF.

Generally any kind of news can always be looked at in a positive or a negative way.

Currently we are in a regime where every news is bad. But please, somebody’s gotta help me out here: with housing inventory at record highs and weighing on the market, why exactly is a collapse in housing starts seen as a bad thing? Do you really want to add even more inventory to an already oversaturated market? Would the markets have risen today on news that housing starts doubled? Oh Lordy…

This morning Bloomberg runs a story about Oppenheimer’s Meredith Whitney, financial guru du jour, who suggests banks to hold a yard sale. She compares them to cash strapped consumers who need to sell their family jewelry at Cashville or their clothes from the 60s in a garbage sale. Why, so she wonders, do banks live to different rules than everybody else?

Miss Whitney, one reason may be that banks actually hold assets. They may be labeled toxic, but most of them are still paying very un-toxic dividends and coupons. Last time I looked, my high school gear was just taking up space, not paying me anything.

Secondly, banks are not cash strapped. The only problem they have are analysts like good old Meredith who think they’re undercapitalized for the Great Depression(TM) ahead. Well, so are probably a large number of Americans out there, and yet nobody forces them to start selling of assets or declare bankruptcy simply because their current net worth is negative. And strangely, nobody asked to have these Americans nationalized either.

I know that Meredith currently can’t do no wrong because she has been right a few times in a row. But I’ve seen enough of these sages go down once the markets turned around. Let me borrow a quote from Princess Leia for Meredith: “Some day you’re gonna be wrong, I just hope I’m there to see it.”

If there is one insight from 2008 that 99 % of all investment professionals seem to agree on, then it is that you should never have banks or institutions that are so important that their failure can trigger a systemic crash. Thus some are actually suggesting growth or size curbs. The idea: Isn’t it much better to have hundreds of smaller banks instead of a handful of big ones? If any of them failed nobody would care. Right?

No.

The problem starts with the fact that most banks run very similar portfolios. If there is some financial product out there that is extremely profitable but not yet offered by some bank, let’s call it Bank Gotham, Gotham’s managers sooner or later by necessity have to offer a similar product, regardless of what they may think of it in terms of risk. If they do not follow suit, shareholders will increasingly grow impatient and question why everybody else is growing so much faster than Gotham. You as Gotham’s CEO can only afford to do this for so long before you’ll be forced to fire your prudent risk managers and replace them with expensive hotshots who successfully ran such products at other banks. And if you don’t do that, your own job as CEO will be on the line.

Okay, so now you have 50 different smaller banks out there, all with very similar portfolios. What happens in such a world when huge financial shocks run through the system, for example a nationwide house prices decline of 30 % within two years? Gotham’s Option ARMs and subprime loans will blow up in their face and before you know it the FDIC comes in and seizes the bank.

Alas, 13 or so other banks have the exact same problem and will all fail simultaneously. So, instead of having one big Lehman Brother going down in flames you’ll have 13 smaller players going down all the same. The overall shock to the system would be similar.

I have to admit: sometimes it is very hard to stay serene. And now is one of those times. When all around you seemingly intelligent people really do believe that nationalizing banks before they have issues is a good idea, then yes, I do lose my patience.

Felix Salmon is almost foaming at the mouth and touts this idea exclusively in most of his posts of late. He quickly dismisses two reasonable alternatives, namely the aggregator bank or the government reinsurance.

Let’s respond to what he said: According to him the aggregator bank doesn’t work, because if it bought assets at the price they’re really worth then the “insolvent” seller banks would still be bankrupt. This is true if and only if a) the aggregator bank pays the current depressed market price or lower, and b) the seller bank sold a substantial amount of their assets today at depressed prices. But what if they only sold off some assets to reduce exposure and take the risks on others, paying out actual realized losses over time as they materialize? Hmm… And what if the aggregator bank believed that AAA rated CMBS tranches with 30 % credit support should be valued higher than 60 cents on the dollar?

He then talks about the difficulties of establishing a fair price. Well, isn’t this the crux of the matter? Why is Felix assuming that current prices are fair prices? They can either be lower or higher. If they’re higher, then where is the problem? And even if they were lower, most of these assets do not mature TODAY, so any losses would be spread out over the life of the loan. So why would you force banks to realize these losses today? On what grounds?

Many of these problems also apply when you look at his dismissal of the reinsurance idea. Once again he assumes that current depressed prices are fair. And once again he assumes that banks would shed all their assets at current distressed marks. Why would they do that again? He doesn’t answer.

No, to Felix the best idea really seems to be to wipe out common stockholders simply because based on dire default rates that all materialize TODAY tangible common equity is gone, regardless whether loans are still performing. This kind of thinking only makes sense when you’re short.

The solution indeed is much simpler: instead of deliberating if one or another approach is the best, do them all. When banks become illiquid or insolvent, nationalize them. If they want to sell assets, set up the aggregator bank and try to do a good job valuing those assets based on conservative assumptions. And if they want to reinsure parts of their portfolio (and thus preserve some of the upside), let them do that at reasonable rates. To avoid the taxpayer footing the bill you could even say that if actual losses exceed assumed losses the bank is still on the hook, but with a somewhat generous payback period (including interest of course).

But what if the government is worried about banks cutting back lending and therefore want to extend unreasonable loans to businesses or consumers? Well, they do not have to force banks or take them over to fix this issue. All they need to do is set up their own bank and offer loans similar to agency mortgages through other banks. Then banks who don’t want to lend to uncreditworthy people and instead delever can do just that.

Common sense. What a concept. Look it up in the dictionary, Mr. Salmon.

P.S.: Here is a good post from the WSJ regarding the current opportunities in banks.

The latest leg down in the markets has me puzzled. Other than the news that Citigroup is selling a stake of their Smith Barney subsidiary to Morgan Stanley and that Bank of America is seeking government support for their acquisition of Merrill Lynch there really wasn’t any major news out there.

The disappointing retail sales data should have been a non-issue. It was widely advertised that Christmas retail sales would drag since … eh …. September. Okay, so sales are down a little over 2 %. Well, stocks are off 40 %. Could any of that be priced in? Hmm.

Why are the Citi and Bank of America news inducing another round of “nationalization” talks? People have complained for years that Citi was too large for its own good. And Bank of America is just asking for the same favor that was granted to J.P. Morgan when they acquired Bear Stearns and Washington Mutual.

I think equity investors are foaming at the mouth with blind panic, oblivious to the dramatic improvement in credit risk metrics all across the board over the last four weeks. In October and November I could understand a 10 % selloff within a few days, but now?!