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There have already been a lot of comparisons between the market collapse of 2020 and the 2008 financial crash. This makes sense - investors hadn't seen a real bear market for over a decade by the time March 2020 rolled around.
However, there is a crucial difference between 2008 and 2020, and that is that U.S. banks are in much better shape today than they were back then.
In fact, while banks were undoubtedly the problem back then, they are arguably part of the solution right now. They will be instrumental in steering much-needed capital to businesses. In his recent remarks at the virtual Berkshire Hathaway BRK.ABRK.B annual meeting of shareholders, Warren Buffett (Trades, Portfolio) gave his thoughts on the current state of the U.S. financial sector.
Not like 2008
Buffett believes that the Federal Reserve has been able to respond to the current crisis a lot more efficiently because, unlike in 2008, it hasn’t had to worry too much about major U.S. banks going under. Following the collapse of Lehman Brothers in September 2008, there was widespread speculation about who was next, who would be bailed out, which institutions would be merged together, and so on. Over the past two months, no one has raised the possibility of any of the big U.S. banks failing:
“I think overall the banking system is not going to be the problem. I wouldn’t say that with 100% certainty, because there are certain possibilities that exist in this world where banks could have problems. They’re going to have problems with energy loans, and consumer credit - but they know it, and they’re well capitalized for it. They were reserve building in the first quarter, and they may need to build more reserves but they are not a primary worry of mine. We own a lot of bank stocks.”
Buffett believes that today’s banks are much better capitalized than they were back in 2008, and that they have far less exposure to risky asset classes. This makes sense; the recent market declines were driven by an event originating outside the financial system, not within it. Will banks suffer losses? Definitely, but there are strong reasons to believe that they will perform better than many other sectors of the economy in the long term.
For one thing, although big banks will undoubtedly take losses in their loan making segments, trading desks have been cleaning up in recent weeks. Traders make their money from volatility - the more violent the swings in the market, the more mispricings there are that they can take advantage of.
Additionally, trading desks at big banks can provide liquidity in times of uncertainty, and as market makers, they can charge large spreads (the difference between the bid and ask price) on securities. So in a sense, a bank’s trading arm is a hedge against the market, even if the trading activities at big banks only make up a small portion of their activities in terms of income. Trading will do poorly during periods of low volatility, but will do well in an environment like today’s. Considering all of these factors, it is unsurprising to me that Buffett thinks banks are in a good position in 2020.
Disclosure: The author owns no stocks mentioned.
Read more here:
- What Investors Can Learn From Great Traders
- Warren Buffett Sold Airlines in April
- Seth Klarman: Value Investing Works Because Markets Are Wrong
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