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The Oracle Is Upbeat

Warren Buffett, always the contrarian, takes a rather sanguine view of the banking sector. From his recent three-hour interview with CNBC:

BUFFETT: Yeah, the interesting thing is that the toxic assets, if they're priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they've got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own. The problems of the banks are overwhelmingly not toxic assets, you know. They may have been one or two at the top banks, but they are not going to do in--if you take those 20 banks that are subject to the stresses, they're not going to do those banks in. Those banks have the earning power which has never been better on new business going out of this to build capital positions even if they pay low dividends which they're starting to do now.
JOE: Hm.
BUFFETT: Toxic assets really are not the problem they were. Now, when I said it was contingent--I didn't remember being exactly contingent on TARP, but it was contingent on the government jumping in.
JOE: Right.
BUFFETT: The government needed to act big time in September, I will tell you that.
JOE: So...
BUFFETT: And they did act big time.
JOE: So you are OK with the shift to providing the banks with capital as opposed to the original intention of the TARP for actually getting the toxic assets off the books?
BUFFETT: Yeah, and interestingly enough, they don't need to supply the banks, in my view, with lots of capital. They need to let almost all of--I mean, the right prescription with most of the banks is just let them pay very little in the way of dividends and build up capital for awhile, and they will build up a lot of capital. The government has needed to say--what the government needs to say is nobody's going to lose a dime by having their deposits in these banks. They're going to make lots of money with the deposits.
JOE: Hm.
BUFFETT: The spreads have never been wider. This is a great time to be in banking, you know, if you just get past the past and they are getting past the past. I mean, right now every time a loan is made to somebody to buy a house--and we're making, you know, making millions of loans--four and a half million houses will change hands this year out of a total stock of less than 80 million. So those people are making good mortgages. You want those assets on your books and you get a great spread in putting them on now. So it's a great time to be in banking, but you do have to get past this past. But the toxic assets, in my view, you know, if they've been written down to market, I'd rather buy those assets from the bank than any other assets they've got.

Basically, Buffett is arguing that because of larger interest rate spreads (the interest rate at which a bank borrows from the Fed minus the rate it charges other people), pre-tax profits in the banking system should be way up this year (perhaps yesterday's Citigroup memo is an indication). This means that conceivably, within a few years, the banks will be adequately capitalized and lending normally. What’s interesting here is that Buffett essentially sees the current banking crisis as a problem of liquidity (the market is underpricing some of the banks' assets), not solvency. This is a more optimistic reading of the banking crisis, and is directly opposed to the many calls for nationalization by Krugman, Roubini, Wolf, et al and what sometimes seems like the whole blogosphere. Let’s just say Buffett won’t be invited anytime soon to party with the horsemen of the apocalypse.

--Sahil Mahtani