- Expect more problems for banks in the near term.
- Write-downs, weak earnings, and government assistance will likely continue.
- But protracted recoveries aren't unusual for large sectors.
- Financials' struggles won't prevent a recovery for the broader market.
Don't expect problems for Financials to go away anytime soon. CEOs know now's a great time to air any dirty laundry—everyone's expecting the worst so they may as well take their licks now. Announcing write-downs or similar losses later in the year runs the risk of trying the patience of governing boards and investors, but for now, more pain is expected. And as long as it keeps coming, you can expect more Banky Panky from the feds.
Bank of America, the largest US bank by assets, today announced a fourth-quarter loss of $1.79 billion—its first loss in 17 years—not including losses of $15 billion at recently acquired Merrill Lynch. The feds, intent on seeing the Merrill deal through, extended another $20 billion to BofA (ostensibly the first pledged dollars from the second half of TARP and similar to the program offered to Citi last month) and guaranteed $118 billion of assets to help digest their new acquisition. Considering earlier this week Fed Chair Bernanke announced further cash infusion for Financials and further guarantees of their debt might be necessary, and the last months' events, this isn't jaw-dropping news. Still, we can't help but notice markets tend to get a case of the yips whenever TARP is mentioned.
And the feds probably aren't done yet. The enticing concept of creating "bad banks" suddenly took hold Friday. A "bad bank" is an entity that takes ownership of non-performing bank assets and attempts to unwind them to maximize recovery value. Sweden successfully pioneered the idea in the early 1990s during its severe banking crisis. On Friday, Citigroup announced it would form such an entity to take on $850 billion of its troubled assets, freeing a remaining "good bank" (Citicorp) and its $1.1 trillion of stable assets to move forward unencumbered. The UK is rumored to be considering forming a "bad bank" at the national level to restore confidence and encourage lending. Even outgoing Treasury Secretary Paulson and FDIC chief Bair are promoting the idea for the US. In our view, with Treasury's extremely low borrowing costs, the US government could easily underwrite a "bad bank" of several trillion dollars and put most all the banking industry on firm footing very quickly.
Of course, given the sell-off for Financials' shares, it's understandable investors would be a bit leery of them for a while. But it's important to distinguish Financials from the broader market. Like Energy in the early '80s and Technology in the last bear market, Financials were the big loser this time around. But while both Energy and Tech struggled to recover in the subsequent bull markets, the bulls materialized nonetheless.
What's the upshot of all this? Though their methods have been suspect, the government has consistently made it clear they will not allow systemic failure of the financial system, particularly the big banks. Continued pain for Financials' shares, so long as the financial system continues to function, won't prevent a broader recovery.
There is no need to sugarcoat this bad situation, but it must be noted that dire headlines lately almost completely ignore the fact that credit markets globally are continuing to thaw.
So let Hank & Co., do the Banky Panky if they must (while they're still around). They might eventually get it right, or at least right enough, for things to move forward.