Thursday, December 1, 2011

Are The Banks Now Bailed Out?

Judging from yesterday's huge rally on Wall Street, and reports of highly successful French and Spanish bond auctions this morning, it would seem that yesterday's coordinated central bank intervention has turned the tide in euroland.

I hope so but I am skeptical.

I had a savvy client email me last night asking whether we should begin buying European bank stocks for his portfolio.

After all, he pointed out, the usual valuation metrics for bank equity analysis are all indicating a sector that is hugely undervalued.

If the central bank actions are effective, couldn't possibly see a rally in financial stocks similar to 2009, when financials nearly doubled from March 2009?

Well, maybe, but I think there are several factors considerably different from those in 2009.

First, I think that the political mood (i.e. anti-banker) is considerably less sympathetic to financials than prevailed earlier.

It's not only the protest movement "Occupy Wall Street" - even the President seems to be running for re-election on a more populist platform. Pushing through bank bailout packages similar to those of 2008-09 seem unlikely.

Second, the Fed is, in my opinion, largely "out of bullets". Interest rates are already at 60-year lows. The Fed's two rounds of so-called quantitative easing has pushed mortgage rates to multi-decade lows (yet housing remains in a funk).

Yesterday's actions added dollars to a world banking system that was starving for liquidity, but it will not change the fundamental credit issues that Europe faces.

Third, I'm not sure that the traditional bank metrics are all that meaningful right now. If the assets on the books of the major multi-nationals were worth anywhere close to reported values, why don't they just sell them to raise capital?

In fact, even in America there is considerable evidence to suggest that the mortgages on the books of US banks are not worth their stated values. Here's a note from this morning's New York Times:

A new analysis suggests that the tide of home foreclosures isn’t going to recede soon.

The report from the Center for Responsible Lending, “Lost Ground, 2011,” finds that at least 2.7 million mortgages loaned from 2004 through 2008, or about 6 percent, have ended in foreclosure and that nearly 4 million more home loans (roughly 8 percent) from the same period remain at serious risk.

Put another way, “The nation is not even halfway through the foreclosure crisis,” says the report, which analyzed 27 million mortgages made over the five years.

Finally, several recent news reports have looked back to the period of 2009 and found that the "all clear" signals that were flashed by bank CEO's were, well, lies.

Here's the report from Bloomberg earlier this week:

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.

And here's what the bankers were telling the press:

Bankers didn’t disclose the extent of their borrowing. On Nov. 26, 2008, then-Bank of America (BAC) Corp. Chief Executive Officer Kenneth D. Lewis wrote to shareholders that he headed “one of the strongest and most stable major banks in the world.” He didn’t say that his Charlotte, North Carolina-based firm owed the central bank $86 billion that day.

JPMorgan Chase & Co. CEO Jamie Dimon told shareholders in a March 26, 2010, letter that his bank used the Fed’s Term Auction Facility “at the request of the Federal Reserve to help motivate others to use the system.” He didn’t say that the New York-based bank’s total TAF borrowings were almost twice its cash holdings or that its peak borrowing of $48 billion on Feb. 26, 2009, came more than a year after the program’s creation.

Like the old axiom goes, "Fool me once, shame on you. Fool me twice, shame on me".

Even if today's situation is more dire than 2008, I think the popular mood will not support anywhere near the level of intervention.

I remain wary of bank and other financial shares.