Banks are for Asshats

Unless you’ve been on vacation in Fiji or just egregiously drunk from St. Patty’s Day, you saw yesterday, a historic moment not seen since the 1930’s, with (JPM: 42.49 +5.41%) stepping in and buying (BSC: 6.07 +26.20%) for just a fraction of it’s book value. They were able to make this acquisiton due to the intervention by the Fed and the Treasury.

As we all know, the Fed is fighting three battles:

1.) The liquidity crisis that is turning out to be a very serious problem for our economy, as it is confronting the deflationary efffects of the de-leveraging of the global financial system.

2.) The banking industry’s credit problems that are just starting out, in my opinion.

3.) Fighting inflation, which is an idea that they have given up on for the time being.

In regard to the liquidity crisis, as you all know, the Fed is meeting today and is widely expected to lower short term interest rates at least another 75 bp, and possibly 100 bp. It’s pulling out all the stops to fight this deflationary effect that we are seeing in the U.S. as a result of real estate prices falling now to a 16-year low.

Not only are real estate prices declining, but the prices of financial instruments are also declining and as a result, the deflationary impact to the financial statements of the broker-dealer community, as well as, some of the global banks has been devastated.

It is apparent now that the Fed, along with the Treasury, will do everything in their power to keep us from going into a downward spiral on the deflationary front. They are doing this by emptying their pockets and boosting the lending capacity of the Fed, as evidenced by the use of authority that they have not implemented since the 1930’s, which means that they will now lend directly to broker-dealers.

The balance sheet of the Fed shows about $900 B in assets, mostly T-Bonds. They have a number of facilities that they have implemented over the past 60 - 90 days to allow people to borrow from them. As we saw last week, they will be taking as collateral value, MBS which have obviously been absolutely crushed into fine powder. If (and hopefully, not when) the Fed runs out of their balance sheet resources, they will have to turn to the Treasury to come in and start buying MBS.

I would also anticipate that this will end up being a global effort of all the central banks, as they are going to strongly fight to prevent a deflationary spiral that could get out of control. This, in the long run will be favorable, as we do not want to go into a deflationary environment like Japan did in the 1990’s, or the U.S. did in the 1930’s.

The banking problems are on the credit side. This has been developing for the past two years and the problems are coming to pass before our very eyes. I am of the opinion that the problems are just starting to pick up. We are going to see some very difficult numbers to swallow in Q1 of this year by the banks.

IT IS WAY TOO EARLY TO JUMP UP AND BUY THE BANK STOCKS!

Banks are not cheap enough yet. When you look at where the stocks have traded in the past, for example in 1990-92, you will see that they traded, in general, below book value. And, because of purchase accounting, these stocks will end up trading below tangible book value and when they drop below tangible book value, that would be the time to start looking at them more favorably.

Earnings will be negatively impacted this year by rising credit costs from bad loans, which always will lead to lower stock valuations for the banks. That being said, it is very clear to me that the stock prices of banks will continue to fall from their current levels.

On the inflation front, the Fed has essentially admitted that it is not their primary fight right now. The primary fight is to prevent the U.S. from going into a deflationary period by creating liquidity. As a result of having given up the fight against inflation, we have seen increases in commodity prices across the board, which has also affected the dollar.

In summary:

The loan and credit problems will intensify and get worse.

The Fed is forced to create liquidity in a very illiquid credit market that has spread across the globe, thus driving down the dollar.

The other big problem, which is different than the liquidity fight, is that the problems in the banking industry will lead to BANK FAILURES, which will probably come to a head later this year.

Stay away from buying ALL bank stocks.

Trade accordingly.

You may want to TAKE ADVANTAGE OF RALLIES to continue to short the financials via (SKF: 116.93 -14.97%), or if you’re a conspiracy theorist, just take your cash out of your local bank and bury it in your back yard. Then go out and buy guns.

Disclaimer: This info is for educational purposes only. Trading on this info is subject to the peril of your own blind risk. Finally, if you do decide to short the banking sector, expect to get a call from your friendly neighborhood banker who will probably be wanting a loan.