It’s time for me to get testy again about my favorite subject: the banks.
The banks have been propped up through massive guarantees, massive bailouts, massive loans, changes in accounting rules, changes in regulations, obfuscation, outright lies and even body language. And the banks and our government have been able to convince people, with vocabulary, not facts, that things are fine.
All of this was necessary in the wake of Bear Stearns, Lehman Brothers, Merrill Lynch, AIG (AIG) and several other major players going belly up or the equivalent thereof.
But enough is enough.
The American people are far more sophisticated than during the Great Depression and much smarter than our elected representatives, and their surrogates, give us credit for.
Simply put, the government is using words to convince us the banks are fine, but reality is going to sink in soon as government action replaces words.
A Quick Vocabulary Lesson
Let’s look at the current vocabulary as it has stood to date and what it really means:
Stress Test: A test designed to prove the banks are fine. Check out this clip from Saturday Night Live — it says it all.
Profits: Numbers generated through accounting gimmicks and one-time events, yet treated by all as sustainable.
Toxic Assets: Assets that if written off would bring down the bank — perhaps the banking system — and are to be forgotten like and ex whose idea of couples counseling is watching “Fatal Attraction.”
Bank Reserves: Money put away to cover future losses after calculating the amount of profit to be (artificially) declared to sustain a stock price. They do not account for toxic assets, default rates, 10% unemployment or zero economic growth.
The FDIC: Santa Claus wearing a red, white and blue suit — the government agency now essentially guaranteeing all bonds issued by banks.
Balance Sheet: The place where banks assets and liabilities meet each other — except when inconvenient.
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OK, now that we’ve looked at the past uses of these words, let’s look at some upcoming changes in the vocabulary — specifically the FDIC and bank balance sheets.
Revised Definition: The FDIC
This FDIC has announced that it is going to disengage from guaranteeing bank bonds. They want the financial system to begin to return to business as usual.
And the question is, how many banks can sell how many bond at what prices?
It ain’t looking good — credit markets are actually in retreat right now except for AAA-rated securities or their equivalent.
Translation: Bank costs will go up significantly as they pay higher interest rates to compensate for perceived risk, or they will be unable to borrow and will have to sell off assets and shrink their balance sheet, incurring losses on bad assets and reducing profits from good ones. And reduced earnings will reduce the value of their stock.
Revised Definition: The Balance Sheet
In January, if things go according to plan (and this could change), the banks will be forced to take their “off-balance sheet assets” — assets they take profits from, but on paper have no liability to support (like Enron, and even using the same legal names that Enron used) — and put them on balance sheet.
Citigroup (C) could be on the hook for more than a trillion — with a T — dollars, and Wells Fargo (WFC) for more than $1.5 trillion. When they place these assets on balance sheet, they will need to raise capital, diluting shareholders.
What to Do
In January, if things go according to plan (and this could change), new accounting rules will force the banks to take their “off-balance sheet assets” — assets they take profits from, but on paper have no liability to support (like Enron, and even using the same legal names that Enron used) — and put them on balance sheet.
Citigroup (C) could be on the hook for more than a trillion — with a T — dollars, and Wells Fargo (WFC) for more than $1.5 trillion. When they place these assets on balance sheet, they will need to raise capital, diluting shareholders.
What to Do
For now, stay clear of Citigroup, Wells Fargo and Bank of America (BAC). Once some of the irrational exuberance in the market subsides, they are all outright shorts.
Citi is worth a buck on a good day (now $4.50), Wells is an $8-$10 stock (now $25), and BAC is worth $5 (now $17).
Also, look at the ProShares UltraShort Financials (SKF) — a double inverse ETF that is very liquid — for a long-term play on the banks.
And keep an eye on Washington to see if it will stick to its guns or if it will continue to use words to prop up the banks in 2010, rather than letting the painful healing process begin.
Let Michael Shulman help you make money on the short side of the stock market. Download a free copy of his new investing guide, Double Your Money — and Double it Again.
