The second part of this headline should be credited to Warren Buffett as his way of describing how dangerous complacency about investment risk can reverse abruptly when a company is finally forced to face the risks in its business.
Two things that can make investors overly complacent about risk are low default rates and long economic periods without a recession, both situations exist today and shouldn’t be ignored. Looking back at the credit crisis, ignoring the significant risks that existed in the mortgage market caused large losses for investors in some financial service companies when mortgages started defaulting. It became very clear after the crisis which companies had managed their companies in a risk averse way and which companies were swimming naked. No down payment loans, negative amortizing loans where you could borrow the interest for a period of time, and no doc loan were not sound. The companies that were the most willing to make unsound loans were allowed to grow the fastest and with high levels of leverage on the belief their real estate prices which served as collateral could only go up.
Eventually, as teaser rates began to reset, defaults ramped up and the companies most involved in these loans didn’t have the balance sheet to withstand the financial crisis while others which had maintained more sound underwriting criteria and more conservatively managed balance sheets fared reasonably well. The result was higher stock prices for US Bancorp and Wells Fargo since December 31, 2007 and a more than doubling in JPMorgan’s stock price while the ones swimming naked as Warren Buffett puts it such as Lehman Brothers, Bear Stearns, Citicorp, Countrywide Credit and Washington Mutual have either suffered material drops in their prices or have gone out of business entirely.
Who Might Be Swimming Naked going Forward?
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