Yes I thought Lehman was a buy – in 2005

I was speaking with an old friend and colleague of mine today, and he reminded me of something I had forgotten. As I have mentioned before I was a stockbroker, and I worked with my friend for a few years. While we were at the same firm one of my bigger positions was in Lehman.

Now at the time, thru most of the 90’s I felt that Lehman was a great buy. It was one of the better managed brokerage houses, and well diversified. It weathered the Mexico financial crisis without huge exposure, and had few losses in derivative trades, that took down Barrings.

In fact after I left the brokerage industry and entered the investor relations industry I wrote a review of Lehman back in September of 2005. At the time the stock was trading at the post-split price of $56.60. That was 2x book value and an excellent price in my opinion. The stock went on to run, reaching a high of $85.80 in January 2007. A nice 54% gain in 16 months. Who would be unhappy.

I believe at the time I stated

“Perhaps as Warren Buffett has said, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

Well it’s been 3 years now and that same investment looks horrendous. I have to admit that if anyone has held the stock all the way down they have to be pissed off. The company ruined its great cash and book value with bad calls in mortgage and asset-backed loans. The fact that a buyer must be found is the clearest answer of how risky the investments they made were.

I have to say that I am glad I am no longer a stockbroker. But I would also like to say that the call I made was correct at the time. And that I believe that I would have pulled my investment in January of this year at the latest, around $66. My posts of that time identifies that I was looking forward to a horrible year, and that is coming to pass as well.

So I am man enough to stands up and say what I called correctly, and what I missed as well.

But I’ll add this. If I had free capital that I could leverage without fear of loss, I’d buy options and/or stock in Lehman right now. With great risk sometimes comes great reward.

Now some would say I am insane. I don’t think so. My bet is that Lehman is too diversified and too large to be allowed to fail. Like Bear Stearns something will be done to mitigate the loss in the company.

There are too many stocks, 401k’s, pensions, and other assets directly tied to the financial institution. There are too many stockbrokers and staff. Too many corporate loans. And definitely too many mortgages to let this go under completely. My bet is that they will be absorbed by another brokerage or bank. Possibly even an insurance company.

And consider this. Politically this would be horrible if it fails. It will hurt both Democrats – because Congress failed to act to help ensure mortgages would not get worse and helped in the loss of jobs – and Republicans – because this is happening on President Bush’s watch.

Plus, if this bank is allowed to fail it will shake confidence in U.S. financials and the Dollar. Loans and Treasury bonds will be called or sold to deflect losses and prevent future hits. The combination of these events and the resulting hit to the economy will be devastating. I would imagine a full 3% of the nation would be sent to soup lines directly.

So if I am right Lehman will be taken over, but at what price? I expect a range of $3.50 to $5. At the top it means a gain of 41%, at the bottom a loss of 4%. I like those odds. Especially in this environment.

Now I could be very wrong. The Government might let this brokerage fail. That will hurt a lot and have repercussions, but ultimately it will be good for the market. But I think seeing Lehman tank or sell for $2 is distasteful for too many. A slight premium to the current close of $3.65 would be a big positive for the market.

And if you have read some of my posts on how I see the economy I don’t think you are too surprised by this outcome.

“The Fed has been providing banks extra money to ensure their solvency, but not requiring that loan reserves be increased. It’s kind of like stopping a leak in your tub by adding more water. The problem is not getting fixed and may get far worse. And all the panic about the mortgage industry seems to have done nothing but whip up polispeak from political candidates and political parties, each looking to sway voters. …

As a result of all these things I expect that the Dow Jones will drop to 10,200 by December. If I am correct about Congress and Senator Obama – for the reasons stated – then I further expect a drop to 9,300 during 2009. A significant bear market indeed.”

I still stand by these thoughts I mentioned in July. I still say Citigroup is the real big fear. I still think that crude oil prices will run back up to $160 per barrel over the winter. I still expect large increases in inflation and unemployment. Freddie Mac, Fannie Mae, and Lehman are the tip of the financial iceberg. Be prepared.

My friend stated

“Well this is just like Xerox and Kodak. Back in the day they were on everyone’s list to own. They were thought to be too big to drop. But today nobody speaks about them. Why shouldn’t the same thing happen to financials?”

That is very true. But the real question is how we transition to the new financial stock leaders. Opportunities always exist in even the worse markets. You just need to sit back and pay attention, and know your risk tolerance.

I may be wrong again, but I’m willing to tell you my thoughts. You can make your own decisions on how best to manage and invest your holdings.

    [By the way, here are how a few other of my calls went.

  • AMD – May 2005 – $16.08 High $40.54 in February 2006 now $5.75
  • AMLN – February 2005 – $22.48 High $50.81 in October 2007 now $20.18
  • ERTS – November 2004 – $47.79 High $68.12 in January 2005 now $44.99
  • SIRI – September 2004 – $3.00 High $7.95 in December 2004 now $0.95

    Just wanted to be clear and honest on what I have publicly said in the past.]

3 Comments on "Yes I thought Lehman was a buy – in 2005"

  1. Comment found at 1800blogger where I am a contributing author.

    Ex-Lehmanite Says:
    September 13th, 2008 at 5:03 am e
    I sold my shares that vested 5/’07 @$55-60. I owe taxes @ $75. There are others who are on the hook for a whole lot of shares @ $75, and they have dick to show for it. That sucks – like the bust all over again.
    I quit the place in 2/’06. When I recieved my stock grant documents, unlike most, I read it. There were 5-6 mortgage origination firms mentioned in this document – I was asking myself, “what the F@#k is all this?!”. All these off-balance sheet investments in these companies to supply mortages to meet demand. This is not a crime, or a particualrly bad business idea. However they violated the #1 rule of drug dealing and securities marketing, “never try your own supply”.
    f$%king idiots…the place is full of half-wits. The best thing I could have done was leave.

  2. Ex-Lehmanite,

    I can feel your pain. There is nothing like vesting in a stock at a higher price than where the stock is trading. It’s fantastic if the stock eventually goes higher, or if you need a tax loss. But these things happen, and often in a weakening economy, or with a company that has made poor business decisions.

    But I wouldn’t equate this to the dot com bust. The internet bubble has caused a lot of the problems today though. The failure to recover from that time, coupled with events like Enron are the causation of what we are experiencing now.

    Because valuations went so high, and demand kept pushing things higher, when everything went bust investors and financials sought out the next best place to put their money. That moved the real estate market into an artificial value. As interest rates were cut, that further fueled the market. And just as with internet stocks the public at large bought housing without understanding the ramifications of future market turns.

    Variable rate mortgages look great, until rates go higher. Sub-prime loans are fine, until the payments balloon. And without ever increasing paychecks the ability to sustain these homes diminishes. So the real estate boom turns into a bust. Something many expected for years after the internet bust.

    Honestly this is all part of the same downward cycle in the market. It’s just gone slowly, mostly due to Government intervention in the worst way. By trying to soften the blow the Government has only extended the downturn and allowed it to become a vortex that take more businesses and investors over time.

    And if we must place blame, which many want to do, then we have to go back to the Clinton Administration that did nothing to curtail the Internet craze which started the whole cycle. His inaction and politically motivated acceptance of the problem has poisoned the golden apples, and here we are.

    But it sounds like you understand this, as was why you were upset with all the loan originations and the off-sheet actions of Lehman. As I stated in 2005 this was not the case and the company was better managed. But as the investments of the company changed so too did my opinion. But I did not directly state this in public writing, so I accept that I can be found to be wrong on the recommendation.

    Of course the bad decisions and mismanagement that created this problem, for all the major investment firms and banks, is why I never worked for any of them. Still the fact the Government is willing to bailout every bad mortgage and financial firm means that they will consolidate and opportunities will abound.

  3. also from

    mike m

    Right on Michael. Clinton not only didn’t do anything to stop it. He caused it with his bill that repealed the Glass-Steagle act. I am an old stockbroker too, and I loved it. This is going to be worse than most people think. There are more shoes to fall. Like you say watch the banks.

Thank you for lending your voice. We appreciate hearing what you have to say.

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