John Mauldin on European Banking Risk, Bank of America, Investing in Biotech Stocks

We had the chance to speak with John Mauldin, president of Millennium Wave Advisors and author of the widely-distributed Thoughts from the Frontline newsletter, on Benzinga Radio this week regarding some of the crazy things we are hearing about the near-term health issues in the European and U.S. banking systems right now. We also discussed where he is putting his money in the face of all of this uncertainty and got his thoughts on matters of regulation. Here is what he had to say. On the possibility of an implosion in the European banking system: John Mauldin: "Europe is at an inflection point; they are at the place where they can easily slide into recession and a banking crisis. This is not John Mauldin talking. This is Christine Lagarde, the head of the Swedish Central Bank, numerous commentators in Germany, anywhere you want to go in Switzerland--none of them believe the story. It's kind of a well-known secret how bad European banks are capitalized and they lend money to their governments that simply don't have the ability to pay. "The crisis comes from the fact that one or more sovereign nations are going to default on their debt. Their banks are typically leveraged at least thirty--if not forty--to one, they don't count sovereign debt that they have lent to governments against their capital structures because in Europe every government official knows that sovereign nations can't default. Since sovereign nations can't default you don't have to account for them in your capital structures. "It's a monumental mess up and its going to come back and bite everyone--the U.S. and everybody right on down. They have been allowed to get away with this. Understand if you can borrow money at one percent and lend it out at three-and-a-half or four, and you leverage up thirty-to-one, you're making an enormous amount of money on your capital. That's what they have done; they have gotten greedy. I know the concept of a greedy banker, and we think of it as Wall Street, but it started in Europe and they really perfected it. "When these countries start taking haircuts on their debt--and Sean Egan thinks that Greece's haircut will be about ninety percent--and once the dominos start toppling, Italy will have to take a haircut and Spain will have to take a haircut for sure. Italy will have to institute some serious austerity if they don't. Well, that will put them into a rolling recession for a couple of years. "While we think of it as just Italy, or Spain, or Greece, or whatever, Europe itself is on the brink. The Germans are five to one against further bailouts. Merkel is losing her control of her party, and there is open rebellion in the back bench ranks. If she is going to pass the next euro bailout, she is going to have to use the opposition. Well, any time you start using the opposition, you're talking about your government failing--that's just the nature of the parliamentary beast. "You could easily see the Germans walk away. At some point they are going to walk away. The question becomes when and how, and whenever that happens, it's a credit crisis. That credit crisis will show up on a shore near and dear to us in the U.S. in the same way our subprime crisis visited them. Houses defaulting in Florida, Arizona, and California--what should that have to do with a small state bank in Germany? Well, enough to put them under; they thought they were buying AAA paper. "That's what the banks in Europe were assured by their regulators--that sovereign nations can't default. Therefore we don't have to worry about it; just keep the party going." On consumer confidence and whether it "feels" like a market crisis right now: John Mauldin: "The consumer confidence numbers that came out [this week] were terrible. It may not be a recession, but if you look at the consumer confidence numbers, the consumer says it feels like a recession. "I think at some point it does become a crisis, but that is kind of what happens. The simple reality is that there are banks in Europe that are already losing their access to the market, and when that happens, it's a crisis. You can dance around it all you want but we have problems in River City." On Warren Buffett's Bank of America deal and what it says about the U.S. banking sector: John Mauldin: "They are just locked out of the public market at a price. If you're willing to meet Warren Buffett's price, you're not locked out of the market. There's money on the table for you and that's what happened. What did they do [this week]? Taking profit on their Chinese investments that at one time were part of the family jewels; they went out and hocked the family jewels as well. That's what you do when you're raising money. "If they keep raising money like they are raising--they clearly have bad assets; just as clearly, management is out there proactively doing what they can to raise money as fast as they can. "A lot of people keep running numbers, and you might have a trillion dollars in non-performing loans, but you only lose two-hundred billion because there are assets underneath to back it. They are out there raising working capital, no question about it--they have a lot of cash on hand. They're doing something now, pre-crisis. They are raising capital--this is what they should be doing. This is what Lehman and Bear should have been doing and didn't. It kind of suggests to me that [Moynihan] is being proactive and getting out ahead of the curve. That's what good management does." On where he sees opportunities in the midst of all of this uncertainty: John Mauldin: "I look around, and if you're a large corporation, you have a lot of cash and you're looking for some weak sisters that have assets that would look good on your balance sheet if you can figure out how to monetize them. So I think you will see more of that type of thing happening; look for good take over targets if you have skill in judging assets in that way. "Commodity trading funds are now starting to be available to the public. I am a big fan of commodity trading funds. You can now find them in funds that are available on your mutual fund platforms. These are traders that have been making money year in and year out as trend-followers. I like that; I like funds that trade. I would like to own natural resources for the long term." On investing in biotech: John Mauldin: "I personally am investing in small- and micro-cap biotech stocks that are in early stage. Not for the faint of heart. I would not suggest anyone to follow my lead on that, but I think--as I have written--that biotech is going to be a bubble, and at one time in my life, dear God, please, I just want to be at the beginning of a bubble. I'm buying those stocks even though I know that they are likely to go down in a recession. I don't know that they will go down. If I could be absolutely, perfectly guaranteed that the stocks that I want to own ten years from now would go down from here, then I would hold off, but I'm not totally convinced that they will. "I'm looking for outrageous upside. I'm buying stocks where if I buy ten stocks, I fully expect three or four to go to zero, then be looking for the ten-to-fifty-bagger on two or three of them, and then the others just to do okay--to be bought by somebody, that type of thing. "I think biotech has been and probably always will be [ripe for M&A activity] because that's the only way the big giants will survive--by being able to buy someone else's technology. That what's they do; how else are you supposed to get through this crisis? I hope the companies on my radar will resist that call to sell and hold out for the longer term. I don't know how successful they will be at that. "I wish my stock--the management I am working with--would avoid that because there is some huge upside. We are talking about, by the end of the decade--maybe within five years--the end of cancer, the curing of all kinds of cirrhosis of the liver and cirrhosis of the kidneys. Viruses, within five years, should be, by and large, something that you can go to Walgreens for to get a patch and slap it on your arm." On financial regulation: John Mauldin: "Government regulations are the biggest hindrance to growth in this country. I was just reading that the average small bank has 1.2 people to deal with government regulations for every one person making loans. What's wrong with this picture? "I think shareholders should be allowed to vote to say, "No, our company does not need to comply with Sarbanes-Oxley. We are perfectly capable of doing it without having to comply with Sarbanes Oxley," and use the old standard of an audit. "For [large corporations], it's no big deal; it's a rounding error in their budget. If you are a $10MM in revenue company and you are spending $1MM on compliance, that is a lot of money. That money could go toward new technologies that will hire new employees. Sarbanes-Oxley was a bane of job growth and job creation in small businesses. It should be totally, utterly repealed, along with Dodd-Frank. "We fixed the wrong things. We didn't fix credit default swaps. CDS need to go on an exchange. They didn't go on an exchange because banks are making too much money. They had enough money to lobby to keep regulators from getting into their personal piggy banks. That is just wrong." find us on Twitter @matthewboesler, @lukelavanway, @BenzingaRadio, @Benzinga