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Is It Time to Buy Banks?
By Anand Chokkavelu
February 24, 2009
After processing Treasury Secretary Tim Geithner's latest plans to save our
financial system, I'm tempted to buy a bank stock.
See, Mr. Market kicked my butt last year. And I want some revenge.
What better way than to be contrarian and pick up shares in the most
beaten-down, toxic, left-for-dead sector this side of the homebuilders?
Why not?
It's not as if we're still worried that banks are going under. After all, the
government has made it clear that the largest banks aren't going anywhere.
Those that were already too big to fail only got bigger:
Bank of America (NYSE: BAC) swallowed up Countrywide and Merrill Lynch.
JPMorgan Chase (NYSE: JPM) grabbed Bear Stearns and Washington Mutual.
Wells Fargo (NYSE: WFC) took over Wachovia.
Any remaining worry that the banking behemoths would be allowed to fail has
been eliminated by the second helpings of TARP love for Bank of America and
Citigroup ... and possibly more on the way.
See, too much is at stake. As fellow Fool Richard Gibbons explained, the
lending banks provide allows our whole economic system to operate. Without this
credit, we wouldn't just be talking about the impending collapse of companies
with inherent problems like General Motors (NYSE: GM) and Chrysler -- we'd also
be talking about the possible bankruptcies of robust companies like Wal-Mart
(NYSE: WMT) and Procter & Gamble (NYSE: PG).
And we won't even get into what would happen to credit-dependent medium-sized
businesses, mom-and-pop shops, and individuals.
The banks -- and the banking industry -- will definitely survive.
But what price survival?
So the banks will survive. They must. But -- and this is why temptation hasn't
turned to action -- survival doesn't necessarily mean that shareholders will
benefit.
Just ask the people who owned Fannie Mae, Freddie Mac, and AIG.
Yes, the government will continue to throw lifelines to the banks, but the
implications for the banks and their shareholders are still undetermined. As
shown by the new curbs on executive pay at companies receiving TARP funds, the
government can and will make the costs of those lifelines increasingly
punitive. It's no coincidence that Goldman Sachs (NYSE: GS) and JPMorgan
suddenly want to pay back their TARP money as soon as they can.
And this may not be the end of it. Recall that the rescue of Bear Stearns last
March was supposed to prevent a financial collapse. It didn't -- a year later,
we're still groping for a stable plan of action.
The government has many tools at its disposal -- from the purchase of toxic
assets to capital injections all the way on up to complete nationalization. And
each of these options could be executed with very favorable or very unfavorable
terms for the banks and their common shareholders.
Think positive?
Now, I'm a confirmed optimist, but given the government-interven tion wild
card, buying banks at this point is more speculation than investing.
Why? Even discounting government-related uncertainty, to invest in a bank, we
must thoroughly understand the balance sheet of that bank.
And that's virtually impossible in the case of investment banks, especially
now. Understanding even one derivatives contract is daunting; properly
assessing the risks of a whole portfolio of derivatives contracts jacked up
with leverage and swapped back and forth by mis-incentivized traders is more
Einstein than Joe Investor.
Thus, I wouldn't touch shares of Goldman Sachs, despite its status as a
finishing school for Treasury Secretaries. And if I wouldn't touch Goldman, I
certainly wouldn't touch Morgan Stanley.
But even when we're talking about banks that have stuck to their commercial
banking roots, avoided risky megamergers, and seemed to navigate the subprime
debacle well -- like BB&T and US Bancorp -- we can't be sure.
Don't believe that the "healthy" banks are healthy just because nothing bad has
come out yet. We've seen again and again in this crisis that everything is fine
until it isn't.
Talking us off the ledge
So I would advise against buying a bank stock unless you have three things:
particular insight into bank balance sheets, an unshakable faith in that bank’s
management, and comfort speculating on the final form of the government bailout
initiatives.
But I understand why it's tempting. When I see age-old companies with dividend
yields hovering around 12.5%, I salivate. In the end, though, I'd rather find
attractive yields attached to excellent companies that aren't living and dying
at the whim of the government.
When the average stock is selling for half off, why take the extra risk by
buying a bank stock? If you're looking for companies selling at attractive
prices (with sustainable dividends to boot), I invite you to view our Motley
Fool Income Investor team's recommendations. A 30-day trial is free. Just click
here to get started.
Anand Chokkavelu still owns long-held shares of Citigroup (sigh). JPMorgan
Chase, BB&T, and US Bancorp are Motley Fool Income Investor selections.
Wal-Mart is an Inside Value recommendation. The Fool owns shares of Procter &
Gamble. The Fool has a disclosure polic
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