Greedy When Fearful

With a Roth-IRA, you can withdraw $10,000 tax free for your first home purchase.

I was originally going to write an article called “Banks are un-investible. Time to buy the banks.”  Jim Cramer was telling people to stay away from the financials almost daily. The Motley Fool analysts on Market Foolery were just as negative.  Just last week, my investments in financials were down huge. Wells Fargo, down almost 20%, JP Morgan Chase, down  15%, Bank Of America (BAC), down 50% (78 billion)! I started buying the major banks in August 2009 so this is from those levels. Remember how great things were during the boom times of August 2009? Exactly. Gold just hit a new record of $1900/oz (gold currently trades to a ratio of fear). Yes, the market is that fearful right now.

There were only two people that I followed who were making sense. Warren Buffet was adding to his position in Wells Fargo. Warren Buffet is Wells Fargo’s biggest shareholder (owning 7% of Wells Fargo, and making up 20% of Berkshire’s entire investing portfolio), and the stock was trading almost exactly at Warren’s cost basis! Then, the Motley Fool Money Podcast sound engineer, Steve Broido bought Bank Of America because he “Thinks it will still be around in 5 years.” Steve joked about it probably continuing it’s free fall as everyone else in the room laughed but I thought “Steve, this one will probably work out for you, it’s just way too cheap here.” My plan was to add to my bank basket (which is way more fun than a financial ETF) and buy more WFC, JPM, and BAC. I knew that BAC had the most upside but it also has the most risk. They just announced up to 10,000 layoffs, they are being sued by AIG for 10 billion for massive mortgage fraud. The market is questioning if they are even solvent.

Then, Warren Buffet announced a 5 billion dollar investment in BAC. This is 10% of Berkshire’s cash, a major investment. Warren wanted to inspire confidence in the market, and he sure did with me. But, I wanted BAC to pay for it’s (Sleazy)slegal ways. Main Street runs parallel to Wall Street. If you own who you pay, you add balance to the system.  My family is young (we can wait decades), and we can handle a lot of calculated risk (we can wait decades). I recently read about people foreclosing on BAC. All this news lead me to the idea:

What if I could get Bank Of America to pay for our down payment on our first home purchase? The irony would be great!

With a Roth-IRA, you can withdraw $10,000 tax free for your first home purchase. With this in mind, I doubled down on our BAC investment at the price of 78 billion bringing it from 5% back to 10% (since it fell 50%) of our portfolio. Banks typically trade above book value, and for BAC, book value is 200 billion. If it makes it back to book value, it will be a 150% gain. That’s Bank Of America paying a huge chunk of our down payment. Now, the pros will say don’t follow Buffett because I’m not getting the same deal he is. Warren is getting a 5% yield, I’m not. But, I’m not here for yield. I just bought Waste Management a month ago for the 4.68% yield, not hard to find big yields right now. Warren has warrants for $7.14 that expire in 2021. What that means, is within the next 10 years, Warren has the option (but not the obligation) to buy 700 million common shares of BAC at $7.14. So, if in 2015 BAC trades at book value, 200 billion (or $20 a share), Warren can buy the shares at $7.14 and they would immediately be worth $20, a 200% gain. The pros talk about how sweet the warrants are but they are only sweet if they are exercised. I’m making a 10 year bet that Berkshire exercises those warrants at least at book value. If BAC goes bankrupt, I’ll lose. But, Warren would lose his sweet, sweet warrants if that happens and his 5 billion in preferred stock investment. By listening to the pros you would think Buffett’s preferred stock is shielded from loses and there is no risk. Not true.

The mortgage market used to be the most stable investment out there. People used to make their mortgage their #1 obligation. They would rather pay than be homeless. What madness! With BAC owning the majority of the mortgages, I’m betting the future rhymes with the past.  I’m betting on the side of the greatest investor of all time and plan to profit right along with him.

Monty