Richard Bove, an analyst with Punk Ziegel & Company, disagrees.  If there was an iceberg, it has melted away.

Tilson and Bove illustrate the lack of consensus on today’s most pressing issue.  Only one of them can be correct.  We look at each of their views, and present our own analysis of whether the glass is half empty or half full.

The Half-Full Glass: Richard Bove of Punk Ziegel

Bove has received a lot of media attention lately, in part for his proclamation (on March 20) that “the financial crisis is over.”  Bove is no stranger to controversy, and his contrarian views are not new – he took the position that the sub-prime crisis would be short-lived over a month ago. 

Bove’s thesis boils down to the following:

• The Federal Reserve acted in a “brilliant” and “innovative” manner by lowering key interest rates, allowing banks and primary dealers to borrow against their mortgage debt, guaranteeing a portion of Bear Stearns’ debt, and (along with the Treasury) loosening the capital requirements for Fannie Mae and Freddie Mac.  He believes these actions go to the heart of the credit problem and, “unlike printing money,” are not inflationary.

• These moves will inject liquidity into the system, allowing banks to stave off runs and invest at rates higher than their cost of capital.  He says “an opportunity has been created that will pump profits into the American banking system” and that such an opportunity (to invest in banking stocks) comes along once every 20 years.

• The theory that housing prices will continue to drop for an extended period of time is “dead wrong.”  This is inconsistent with historical evidence, which shows that real estate prices do not drop during a period of commodity inflation, as we are currently experiencing.  Bove cites his own experience in Florida, where “foreigners can and are buying prime real estate at deeply depressed prices with very, very cheap dollars.”

• Beyond providing liquidity, Bove expects a bailout of the housing industry.  The plans proposed by President Bush, as well as by Democrat Barney Frank, will together accomplish this.  Bove objects to the increased level of regulation which would be imposed under the Bush plan, but still cites it as a necessary ingredient to the overall solution.  He is highly supportive of Frank’s plan, which in part calls for the FHA to provide $300 billion in additional credit to refinance mortgages, while the government takes a second mortgage payable at the time of sale of the house.  Bove believes both plans will become law, a likelihood that is enhanced by this being an election year. 

Bove has advocated a plan similar to the Frank plan for months, and believes it will penalize the bad lenders, allow homeowners to avoid foreclosure, repay the holders of collateralized debt and “reestablish the credibility of these securities,” as it cleans away the “financial garbage that is now depressing the markets.”  Furthermore, the plan can act as a template for the private sector to undertake similar refinancing without government intervention.

As a historical precedent, Bove cites the 1990 banking crisis with third-world debt, arguing that the current crisis is actually less severe than that one.  While acknowledging some similarities in the two crises, he cites a number of important differences:

• There are currently no problems with third-world debt.

• There have been no failures among companies held by private equity investors, whereas in the 1990 crisis there were failures among LBO-funded companies.

• Commodity prices are rising, as opposed to 1990, when they were falling.

• Commercial real estate appears to be facing “no real problems and the default rates are low,” according to a recently released Fed beige book report.  In 1990, there was a glut of commercial real estate.

• Currently, very few banks are on the FDIC watch list and only a handful of banks have failed, whereas in 1990 there was widespread failure among banks and thrifts.

In both the 1990 banking crisis and the current housing credit crisis, the credit derivatives markets were imploding.  Bove’s analysis reaches a critical juncture when he states “if the crisis today is worse than 1990, it would be because the credit derivatives markets are failing to such an extent that the financial firms serving them cannot recover. This requires the single family mortgage market to implode.”  Bove then assumes that 50% of the $1.2 trillion sub-prime mortgages will default, and that 85% of this amount - $500 billion – would be written off.  This represents slightly more than 1% of the $48.8 trillion of outstanding debt in the US economy, an amount the financial system can absorb, albeit painfully.  These write-offs would cause the failure of a few institutions, which ultimately would be healthy for the financial markets.

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