Munger

"Do you really think that the banks are going to be in this situation both all other companies are twirling around singing Walking on Sunshine?" Yes -- I think if equity (i.e., stockholders) of some large banks got wiped out (I am NOT predicting this scenario), the country would go through a tough period but the country and the capitalistic system would survive, with the best companies thriving over the long term. I own companies that I believe could survive the worst case scenario, recognizing that the stock prices can easily go down over the near to mid term if some of the large banks go bankrupt.

"If you are under that illusion, try defaulting on an unsecured loan and see what happens." regardless of the legal consequences the debtor faces for defaulting, the bank still gets nothing. At this point, the only "right" or "wrong" will be shown with passage of time. After thinking this through, I agree with Denninger that unsecured credit represents a meaningful risk during periods of stress. You disagree (as do some others) -- here is the solution...buy bank stocks hand over fist because Mr. Market is giving you the opportunity of a lifetime if you are correct. And if I'm wrong, I live to see another day because I am not short these stocks.

How many times do I have to repeat. During periods of STRESS, the capital associated with unsecured credit comes into serious question, which greatly heightens the risk of investments in bank stocks. "I suppose contractual rights are worth nothing." -- here is the point, those contractual rights get you NOTHING if the borrower can't pay the bill, which guess what happens A LOT during periods of stress...there is no recourse and consequently, the capital is complete air.

So wait -- "dealing daily with unsecured lending" gives you the ability to "claim" that the assets are really/honestly/i'm telling the truth secure because we banks make sure to only give unsecured loans to people who are secure...c'mon Capital related to unsecured ledning evaporates during periods of stress.

"However the lending criteria imposes higher requirements on the unsecured borrower. In other words the borrower must have a greater ability to pay than with a secured loan." You assumed this "criteria" secures the loan...you're kidding right? Unsecured lending is complete air.

No -- bmichaud is WRONG. "It doesn't matter what those assets are comprised of" I assuming you are familiar with unsecured lending? The asset behind unsecured lending is complete air. During periods of stress, this risk and the risk associated with the accounting gets greatly heightened. Unsecured lending and the accounting of the corresponding capital creates an enormous air pocket that disappears when you actually need to access that capital!

Kraven -- I have no question. Nor do I criticize your personal conclusions re bank stocks -- in fact, I hope those decisions work out for you and everyone else on this board. I am simply highlighting a risk related to the accounting for capital that gets greatly heightened during a period of stress and collapsing stock prices.

Cayale is pretty good at throwing insults but not much esle. How does someone afraid to invest in bank stock becuase he fears rising interest rates feel so bold to level personal attacks. Paid in capital is nothing but air -- in times of distress and collapsing stock prices, this is extremely relevant or should be to any rational investor.

I'm not trying to accomplish anything. I don't believe you understand paid-in capital.

Kraven -- no let's deal in the real world....BAC didn't sell stock yesterday or any time recently. There is no available cash correspoding to the book equity counted as capital. So as we sit today -- if BAC needs to access this capital there is no way but to sell stock, which is impeded every day the stock price collapes. As I think through this, I believe Denninger is spot on, especially as stock prices collapse. Counting book equity as capital to lend against is insane. Investing on this basis is equally crazy. I seriously hope you aren't relying on book equity as the basis for a sound investment in bank stocks -- you should think beyond simple accounting measures...no? Step 1 in investing to ignore what the accountants tell you.

"If BAC issued and sold 100 shares of stock to someone for $6, they would have $600 in capital added to their ratios. It doesn't matter if tomorrow the stock is $5 or $50." Sure it does -- if there is a claim on that capital, there is NO CASH available related to this "accounting capital" to pay the claim. The only way to access cash related to this capital is to sell stock. I seriously hope you aren't relying on book equity as the basis for a sound investment in bank stocks -- you should think beyond simple accounting measures...no?

I do not believe for a minute the books have been scrubbed clean. I can also assure you that bank stocks are not collapsing because of a concern that interest rates will rise to punishing levels any time soon. The concern right or wrong is BANK CAPITAL LEVELS relative to ASSET QUALITY. No one outside of bank management themselves has any certainty in this regard. Those willing to have blind faith in management marks reminds me of LEH and Bear Stearns. I'm not saying current TBTF banks are LEH or Bear Stearns (I don't know) but the faith of the bulls reminds me of the faith of the bulls in those companies when they were imploding. Subsquently we learned that comments from those management teams we complete lies. We also learned that most companies that claimed they were well capitalized at the time would have failed if the Fed had not bailed them out.

In the spirit of continuing the information flow -- Denninger got questioned on his blog in the same manner that some have here...his response is in quotes. "Rick: The problem is not the equity value "per-se", its the implication that you can raise more capital, and whether the so-called "capital" you have actually exists or has it dissipated?" "The problem with the paid-in capital is that there's an implicit assumption (since you use this as part of the capital base) that you can go get more if you need to. Well, you can't in a situation like this, because the price is collapsing. So now what? You get hit for the entire amount of the judgment demanded in the equity valuation when the suit is filed and now if you lose you're utterly ****ed as you can't issue into a market that values your stock in the toilet. Preventing "recycling" of reserves stops this ****. If you have a "one dollar of capital" requirement then this can't happen, since every dollar of unsecured lending has to be secured with a dollar of capital from either paid-in capital (sale of capital stock), retained earnings or sale of bonds. Since there's no "recycling" of unsecured lending you cannot get into a cascade failure scenario where the depositors lose their funds - worst case is that the investors lose their money (including the bond buyers.)"

Mike Mayo downgrades BAC to SELL.

cayale -- I have no position long or short in any banks. And my opinion has zero influence on bank stocks. So no need to make this personal. I'm just passing along relevant information. Denninger typically doesn't make a mistake in this regard. And you should obviously act as you see fit. Personally -- I wouldn't go near the TBTF banks...no way no how. There are better opportunities. And not worth my time to try to figure out the unknowable -- i.e. the quality of TBTF balance sheets. Anyone who thinks they have any special insight into the TBTF balance sheets is sadly misguided -- all may turn out well, but an investment at this point is nothing more than speculation and don't kid yourself otherwise. I was bearish on banks when Tepper pumped on CNCB and have not changed my view since -- working out ok for me.

From CNBC -- "Tepper's Appaloosa Exits Financials" I don't know David Tepper and he could well be a great/honest guy but his performance on CNBC last fall didn't come across well.

Denninger usually doesn't make mistakes in this regard -- does his homework. Either way -- I wouldn't want to be long banks. Anyone who believes the assets have been honestly marked must also believe in Santa Claus. Economic growth can cure a bad balance sheet but if we're heading into a downturn, trouble ahead.

I am not a bank expert by any means but as I understand (and have read from several sources) -- stock market capitalization is counted as capital. From Karl Denninger, whose tone is rough but he is usually accurate in these areas... "Note that given the utter fraud of allowing a bank to count "equity value" as capital, when it cannot be spent and is subject to 10% or more swings in value in a single day, means that precipitous stock price drops like this can instantly render a bank insolvent. We could have fixed that in 2008 and 2009 but of course that would have meant that banks would have had to actually go find capital from real people to make loans with, and that was unacceptable - so in addition to allowing them to "mark assets to fantasy" we also allow them to count as "capital" things you can't spend, thereby allowing them to generate profits from that phantom "capital" - and huge losses when the deception is revealed."

And to state the obvious -- if the banks implode again...all bets are off. On the positive side, we would then get an opportunity to go "all in." JPM down 5%+; C down 8%+; BAC down 13%+ -- these declines are ominous given that stock market capitalization has incredulously been allow to count as bank capital. If a self fulfilling downward spiral has begun, look out below. And given the S&P downgrade, tough to see how a bank bailout is politically feasible.

Allowing the banks to count stock market capitalization as capital that can be lent against never made any sense and is now coming back to haunt. As stock prices collapse, banks become more insolvent by the day without any connection to the quality of their assets. Downward spiral. Who did the regulators and banks think they were kidding w this accounting gimmick? -- ultimately market forces always prevail. Adding to some core positions but this is not the time to be "all in" -- the only time to be "all in" is during extreme valuation disconnects for blue chip companies...we're not close to such an opportunity. I keep hearing stock yield vs treasury yield implies tremendous buying opportunity -- doesn't take into account bond yields artificially depressed by Fed -- and again, market forces will always ultimately prevail.

For those who think we're just going through a soft patch (which I don't and consequently I don't own the stock), here is a nice little value play. $567 million market cap @ $8.80/share roughly $450 million (some would argue $550 million+) of unecumbered owned real estate $345 million of debt/capital leases $90 million of FCF Surprised this hasn't hit the radar of BH -- right in his wheelhouse.

Straight from the horse's mouth...worth watching if interested in Dell -- see link below. As previously mentioned, i claim no special insight into the future of Dell but if the company can simply maintain existing FCF and continues to buy back stock, a boatload of money will be made in this investment...if FCF grows, huge upside...and the fortress balance sheet provides an excellent margin safety -- if FCF got cut in half from current levels, you wouldn't lose much money...the risk/reward is outstanding. Dell has bought back more than $1B of stock since the end of the first quarter (April end). Didn't realize that Dell is the #1 healthcare IT provider in the world -- not a bad place to sit. Michael Dell also touches on the scale and depth of the distribution network, which I believe is a competitive advantage in addition to the CEO himself. He also puts the tablet craze in perspective. Most important, Dell asserts he is most confident about the company's ability to grow profits. Now if the global economy falls apart (which is unquestionably a risk), the Dell business will be affected but the balance sheet and FCF provide excellent margin of safety as well as the gunpowder to capitalize on the weakness of competitors that will struggle in such an environment. Also offers interesting insight on the unemployment problem. http://video.cnbc.com/gallery/?video=3000030500

I sincerely apologize to anyone who read my post on ITEX -- I made a mistake. However -- no regrets on selling the stock...not comfortable with the CEO share gift. Excellent business model economics, great balance sheet, and undervalued company -- so there is def potential to make money in this stock but the CEO is not for me. Here is the mistake.... I also follow a company called Iconix -- an 8k re their Iconic cam in on my newsfeed today and I quickly read, mistaking for ITEX. Iconix -- is an interesting company. The CEO has created a lot of value. Business model economics are outstanding. However, too much debt on the books for me...but worth monitoring if they commit to paying down debt.

I had started a position that remained tiny because the stock is so illiquid and the recent share gift to the CEO gave me pause. Nice business model economics, excellent balance sheet, and the stock appears extremely undervalued if trailing cash flows can just be sustained. However -- given the 8K filing this morning, I have liquidated all shares in the company. The CEO appears to believe ITEX is his personal piggy bank. The compensation package is egregious for a company this size -- cash salary will equal 50% of annual FCF!!!! Moreover, the CEO reloaded with an additional share gift. Worse -- he announced that he is selling stock despite the company being so undervalued. History shows that this behavior by the CEO often leads to disaster for shareholders. Highlights the appeal of Michael Dell -- over the past 18 months he has purchased $200 million of stock with his own money, adding to his multi billion $ stake...this doesn't guarantee success for DELL but I like having the CEO on our side. Some (most?) on this board don't like Biglari but wouldn't mind unleashing him on this company/CEO -- I know he owns some stock.

Munger would you mind giving more details on where exactly those businesses are in big trouble? I am not aware of any of their business that aren't struggling. The company has been poorly managed. This week's Barron's provides an example. The spat between long-time partners Oracle and Hewlett-Packard is personal, and it's getting nastier. The latest in this ongoing melodrama is the Hewlett-Packard (ticker: HPQ) lawsuit filed last week against Oracle (ORCL), accusing it of breaking a longstanding agreement and defaming HP in the process. At issue is Oracle's March announcement that it will no longer provide database support for the Intel (INTC) Itanium microprocessor that's used in high-end HP servers. Oracle's core business was always software—for decades, big databases, then an arsenal of corporate-application software it amassed through acquisitions. HP, in the corporate market, has been mostly a hardware heavy—and the supplier of Itanium-powered servers to some 140,000 big business customers. The two companies' complementary offerings made for a near-perfect partnership. Then things changed. Itanium never really lived up to its promise, as corporate computer users embraced another more popular microprocessor architecture, called x86. Intel developed the original x86 architecture, but competitors, such as Advanced Micro Devices (AMD), helped push x86 servers to the forefront of the business, at first at the lower end of the server market, then in progressively more advanced servers. Meanwhile, HP's high-end Itanium line competed directly with Unix servers based on a super-fast chip developed by Sun Microsystems, called Sparc. Then Oracle bought Sun, giving it a foothold, and a substantial business interest, in hardware for high-end servers. To be sure, Oracle's announcement that it will not provide support for Itanium servers will eventually mean that customers wanting to upgrade to Oracle's newest databases will have to buy non-Itanium servers, which presumably could include Sparc servers from Oracle. In its lawsuit, HP is calling this move by Oracle, once its arm-in-arm partner, anti-competitive. Oracle responds that Intel was eventually going to phase out Itanium in favor of its x86-based Xenon chips anyway, and it argues that HP—as the most important user of Itanium processors—knew about this, but did not raise the issue with Oracle. In a statement responding to the lawsuit, Oracle described the situation this way: "In September of 2010, HP asked Oracle for a long-term commitment to support Itanium. At that time Oracle did not know that there was a plan already in place to end Itanium's life. Oracle did not learn about that plan until six months later, in March 2011." According to Oracle, the key to the spat is that when HP specifically asked for long-term support of Itanium in September, Oracle declined to make that promise. HP has filed a lawsuit anyway, contending that Oracle is still obligated to support HP's high-end server line. REGARDLESS OF WHAT HP AND ORACLE KNEW, and when they knew it, HP's server business will be the biggest loser. To be sure, corporate-enterprise technology is a cut-throat business, and it becomes no less bloody when former partners are constantly taking each other to court. Oracle Chief Executive Larry Ellison stirred up a hornet's nest at HP by hiring former HP chief executive Mark Hurd. But lest we forget, at the time of the hiring, the HP board had already fired Hurd. The guy was out of a job. Of course, HP punched back by hiring Ellison's former No. 2, Ray Lane, as its non-executive chairman, and Leo Apotheker as CEO. As a former CEO of German software giant SAP, which is Oracle's largest competitor, Apotheker was public enemy No. 1 in the eyes of Ellison & Co. These people really hate each other, and you can't make this stuff up.