Good morning. Meta, formerly a moonshot on whatever the Metaverse is, announced last night that it would pay a dividend for the first time and was adding to its buyback authorisation. The stock rose 14 per cent in late trading. We have seen the future of the Magnificent 7, and in that future they are value stocks! But we would say that, wouldn’t we. It may also have helped that Meta beat Wall Street estimates and issued strong guidance. Amazon and Apple beat estimates too. Big Tech, like the US economy, just does not seem to be slowing down. Email us: robert.Armstrong@ft.com and ethan.wu@ft.com.
Friday interview: Dick Bove
Dick Bove (pronounced bo-VAY) has spent more than half a century as a banking analyst, becoming widely known for bold, contrarian and sometimes prescient calls. He retired at the end of last year. Below, he sums up the lessons of his long career in his famously plain-spoken manner — and argues that the banks are headed for trouble.
Unhedged: You’ve had a long career. Looking back, when you think about your most consequential calls or positions, what do you think of?
Dick Bove: The first consequential call came in the 1970s. In 1972, housing starts hit the highest level in the history of the United States. That was because the US had made the decision in 1968 to build 26mn housing units. Financial structures were changed to allow money to flow into the industry. The government created Freddie Mac, Ginnie Mae, mortgage-backed securities, modified mortgages and subsidised rates for homeowners. It was a 1 per cent mortgage era.
By 1978-79, I became convinced that the US was over-housed. At the time, I indicated that housing starts would not get back to the ‘72 level for at least a generation. And of course, they never got back there until the 2006-07 period.
The second big one I was correct on was my 2006 report “This Powder Keg Is Gonna Blow”. Basically, I defined what was wrong with mortgage markets. These “modified mortgages” entailed you buying the home, borrowing the money and paying 1 per cent on the mortgage for three years. Then at the end of the third year, the mortgage rate would jump to a market rate, and all the interest which you didn’t pay in the first three years would be added to the balance of the loan. So when you got to the end of the modified period, all of a sudden you owed more money on that house and the interest rate had jumped to a market rate, which was roughly 7.5 per cent. You couldn’t afford it. We also pointed out the fact that funding for the industry was coming from the creation of questionable securities, such as [collateralised debt obligations]. That one worked out well for me.
Unhedged: Those were your big successes. How about your big misses?
Bove: I’d been following Fannie and Freddie since I started as an analyst, both as a housing analyst and as a banking analyst. When President Trump was elected in his first term, Treasury secretary Steven Mnuchin went on television and said these companies have to get out of conservatorship [the government bailed out the two mortgage insurers in 2008, and in 2012 announced that all future profits would be “swept” into the Treasury]. Trump appointed Mark Calabria as the head of the Federal Housing Finance Agency [the Fannie and Freddie umbrella organisation]. He went everywhere, talking to every news organisation, every lobbying group, saying, “I have the power to make these companies free. I can take them out of conservatorship.” And he was right. The Housing and Economic Recovery Act of 2008 gave him the power to do so.
I believed these guys. But when push came to shove, Calabria didn’t do it. I had sold my soul on the basis that these guys would live up to what they said. I’d put just about every client I knew into the stocks [which continue to trade, despite the profit sweep]. I’d owned the stocks personally. But they didn’t take them out, and the stocks absolutely collapsed. That was a massive mistake on my part.
The expectation now is that if Mr Trump gets elected president, he will live up to the promise. Anything positive related to Trump’s campaign pushes the stocks up. These stocks have tripled. But I don’t think they’re going to do it. Fannie Mae is paying something like 92 per cent of its revenues to the government, and Freddie is something like 73 per cent. That’s $40bn a year; over the life of a presidency, it’s maybe $160bn. So with Congress having fits over the size of the deficit, I don’t think there’s a prayer in hell that Trump is going to take Fannie or Freddie public.
Unhedged: Turning back to banking for a second, it seems to me that some of the big banks are doing OK, despite all the regulation. Bank of America and JPMorgan are reporting quite good profits. Some of the regionals are doing OK, too.
Bove: Earnings weren’t good in the fourth quarter. The banks you mentioned are losing market share to their competitors. And they have balance sheets which are financially sound, but highly questionable in one respect. Both of the banks you mentioned and all of the regional banks have a lot of fixed-rate mortgage loans on their books. And those loans are not worth anywhere near what they listed as. That’s why First Republic went under. They have hundreds of billions of dollars of Treasuries, again, with a listed value above true value. That is what drove Silicon Valley Bank out of business.
The money supply in the US has jumped by $7tn [since the start of the pandemic]. That’s nearly a 50 per cent increase. But that didn’t happen at any of those banks. Those banks did not capture those deposits; they were captured by the capital markets sector and by private equity funds. Companies like SoFi, it’s now a $30bn [in assets] company. The banks are overstating the value of their equity, and they are not keeping pace with the market. And they’re looking forward to, soft landing or not, a significant increase of loan losses in two sectors: the commercial real estate market, which everybody talks about, but far more importantly the consumer market.
So I don’t think there was anything in the last quarter to suggest, to me at least, that these earnings were good. I thought they were bad earnings. The banks got lifted not because of earnings but because of interest rates. The market expectation is for six [Fed policy rate] cuts. Where that hits is in three portfolios: the auto portfolio, the home [mortgage] portfolio and the Treasury portfolio. The real value of all those portfolios will go up. And historically in banking, that is what drives the prices of bank stocks.
Unhedged: You have spoken in the past about big banks as guardians of national prosperity. Now that there are these other sources of credit, from non-bank lenders to private credit, is the fact that banks are losing market share to other credit providers bad news for the American economy?
Bove: The banks are the core safety valve of the financial system. The fact that they are losing market share to entities that are not protected in any fashion is extraordinarily scary. If you go back to the 1930s, the government attempted, with the Glass-Steagall Act and other [laws], to shore up confidence in the American banking system, and the banking system then became the source of funding for the economy. And by the way, when you go back to 1958 through 1970, the government doubled down on the guarantees that it was giving the financial system.
But with the Dodd-Frank Act in 2010, they started unravelling those guarantees. Banks can no longer protect companies that are going under, the way they used to in the past. The Fed cannot automatically give money to failing banks. Now what they’re doing with this new set of regulations [the Basel III endgame] is they’re setting the banks up so that they cannot protect the US economy, because they can’t make the loans that they were making previously. Let’s assume we ran into another housing crisis. Private equity firms own hundreds of thousands of houses in the United States. What the hell’s going to happen there? Who’s going to protect on the downside? No one.
By making it so expensive for the banks to lend, they take the banks out of the picture. You can call up Jamie Dimon, and after he curses up a storm, he will tell you what he thinks of these regulations from a competitive standpoint. And then he’ll end by saying, we’ll deal with whatever happens. He’s one of my great heroes; he’s smart enough to do that.
The point is that the banking system is being de-risked, the government’s relationship to the financial system is being de-risked. We’re throwing all those loans out into the marketplace under the hope and expectation that the originators of those loans have enough capital to protect them, and they don’t. In a recession, funding dries up and you don’t have any FDIC insurance, which causes people to run to the banks with their deposits. You’re going to see a major problem [at the non-bank credit providers].
Unhedged: How would you respond to criticism of so-called superstar analysts, folks like you who have made a name for themselves by making bold predictions? The criticism you hear is that you’re more focused on getting on TV than making the right call.
Bove: If you’re an analyst working at a small firm, which I have been doing for the last 16 years, you don’t have 5,000 salespeople out there pushing your product. Somehow you’ve got to get the buyer of the stock to look at what you’re doing. In order to do that, you’ve got to create a brand name.
What choice do I have? I’ve got to make bold predictions. If you go back, every one of them, I believe they’re supported by the numbers. Any prediction that I’ve ever made, whether it’s right or wrong — I would say 53 per cent have been right, 47 per cent wrong — I can back up with numbers and history. But understand the mechanism: if I want to be paid by investors, I have to get in front of investors. If I have no salesforce, because I’m working for small firms, I have got to get to the media. And that’s what I did. Whether that’s right or wrong, who the hell knows.
Unhedged: More generally, then, how do you think about the role of the analyst and how it’s changed?
Bove: The role of the analyst has changed extraordinarily since I’ve been in the industry. When I started in the late ‘60s, mutual funds were coming into their own. Consumers had a lot of money [to invest]. Mutual funds started to take off like rockets. Everybody was concerned that mutual funds were not properly managed. So the “prudent man rule”, which dates back to the 1800s, was brought up all the time: you had to prove that you’ve done significant fundamental research on whatever you’re putting into that fund. As a result of that, you had a bunch of firms that were solely doing prudent-man research.
The analysts were gods. They ran everything. Everybody thought the analysts were the top of the industry. But then you got to the late ‘70s, and the analysts didn’t see the market collapse coming. They blew it. And all of a sudden everybody said, these guys are not gods, they’re just like everyone else. They are [idiots]. So now the industry had to decide what to do with all these analysts. The solution was we’re going to use the analysts to support our [investment banking] efforts.
If you ask me the biggest embarrassment of my career, it was that I fell into that position like everybody else. The corporate finance departments were using analysts to bring in corporate finance business. You would go out and you would have to promise the company going public that you would not step away from it if times got bad, that you would support it in the market, that you would do an intensive job selling that company’s stock.
That worked until 2002 when the guy from Merrill Lynch whose name I forget [Henry Blodget] publicly stated that this company was no good while having a strong buy recommendation on it. That scandal resulted in a whole set of rules being created. And now you’re back to the same problem. We don’t need the analysts for research. We can’t use them for corporate finance. What the hell are we going to do with these guys? You had a swing in where the profit centre was in the brokerage industry, towards trade execution. The traders became kings, and rightly so, because they are executing the sale. So you figured out how to use the analysts: to support the trading activities of the firm. You’ve gone from the analyst being at the very highest rank in the industry to being at the lowest rung in the industry, because nobody thinks you need them. A lot of guys do really phenomenal work for many hours, and nobody gives a damn about what they write.
Going back to Fannie and Freddie, people call me and say, what do you think? I say: I think that they are not going to go public. They say: yeah, but what if Trump gets elected, he wrote this letter to the appeals court? I say, yeah he wrote the letter, he’s not going to take him out now because he’s not gonna lose the money. And everybody says, I don’t give a shit what you think, Trump is going to do it, we’re going to buy the stocks, and the stocks have tripled. Research is dead as a driving factor in the market.
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