Investors in big U.S. banks should be asking that question. Today the “word on the street” was that beleaguered bank Washington Mutual may get a life-line tossed to it. Private equity firm Texas Pacific Group (TPG) is said to be in “advanced stage” negotiations over a $5 billion bailout deal for the troubled mortgage lender.
Shares of WaMu soared 29% higher today on that news, pulling most financial stocks along for the ride. It was the biggest gain for WaMu shares in 25 years, which sounds like a lot, until you realize the stock has plunged 75% in value over the past year! But TPG is a premiere private equity firm (well connected with the Bush family). Surely they wouldn’t be putting their hard-earned cash to work in a shaky bank.
The reality is that TPG is hardly spending paper-money – that is to say actual cash – on this deal. Like so many other private equity outfits, hedge funds, and other “distressed asset” investors, TPG’s equity capital is highly leveraged up: 10 to 1... 25 to 1... perhaps even 100 to 1... who knows. So TPG is buying with “plastic” not paper money – just like so many Americans do at the mall.
Buy me $5 billion worth of WaMu shares... and bag it in plastic please!
WaMu needs the cash – after reporting $3 billion in mortgage loan losses and other assorted (or sordid) asset write offs. That’s just a drop in the bucket compared to the staggering total of $232 billion (and still counting) in world-wide financial sector losses suffered so far in this credit crunch market shock.
Shareholders of WaMu should at least feel somewhat relived (hence today’s big rally), even though their existing interest in the bank will be sharply diluted. The alternative however could be much worse.
The good news for other investors – or for would-be bargain shoppers – in the financial sector is that this deal is another signal that the “all’s-clear” has been sounded in the global banking sector.
Don’t get me wrong: there will still be PLENTY of losses recorded this quarter, next quarter, and beyond. The credit crunch isn’t over yet. Mortgage rates are still uncomfortably high. And who knows how much lower home prices will go – triggering even more loan defaults and foreclosures.
Still, it’s worth remembering that the stock market is a “discounting mechanism.” Share prices often bottom well ahead of the fundamentals. In fact, the S&P 500 Index already suffered a decline of nearly 19% from its October 2007 high, to the March low (see chart above), so the benchmark blue-chip stock index may already be three-fourths of the way through this bear market.
The average U.S. bear market since 1940 lasted about 13 months. Interestingly, on average 74% of the bear market decline was over (in terms of time) by the time the market crossed the -20% mark. Also, there have been many market corrections that stopped just short of the down-20% threshold that commonly defines a bear market.
The bulls are crossing their fingers that last week’s rally was something more than just another dead-cat bounce. It certainly looks to me like this rally might have more legs than previous upside moves that proved to be false-starts.
The question now is” should bullish investors buy with paper or plastic?
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