Deficiencies of the Valuation Approach: IndyMac Bank Failure
The basing of investment upon valuation will often lead to absurdities. Not only are some companies unsuited for appraisal due to the risk of technological disruption, inconsistent earnings, etc., they may also be subject to reflexivity (a.k.a. “self-fulfilling prophecy” or “Barnesian performativity”).
On July 11, 2008 the OTS took control of IndyMac Bancorp, marking the third largest bank failure in U.S. history. Depositors had withdrawn money at accelerated levels throughout the week after Senator Chuck Schumer warned that it might become insolvent. Fears of insolvency quickly led to insolvency.
There have been numerous cases of reflexivity during the past year: Bear Stearns’ takeunder, the mortgage and student loan securitization “freeze” and the financial strength rating downgrades of various monoline guarantors. The moral seems to be that valuation is not an adequate measure of investment attractiveness. Rather it is only one component of mathematical expectation, which I have consistently advocated as the superior model. This led me to the arbitrage of IMB and IMB LEAPS (detailed below) instead of a straight common stock investment.
