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G&G Associates Tax & Financial Consulting
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Time to Short These Two Banks
Hotep G&G Readers,
As you could probably guess, the “Big Brother Banks” already snared the lion’s share of the government’s bailout money.
Ever since, you would think they would be performing better. But instead, earnings at these major institutions were VERY disappointing as they closed the books on 2009. Specifically, Citigroup and Bank of America reported major losses on loan write-downs.
At the same time, the new accounting rules allow these poor excuses for banks to easily overstate assets and understate liabilities.
That’s worse than troubling. It’s just wrong.
Frankly, I wouldn’t touch banks like these with a 10-foot pole right now. I don’t care if that means I can’t profit day trading bank stocks all day long. But as a short-seller myself, I can tell you how to profit off the two worst financial institutions out there. We’ll get to that in a moment…
What It Really Means When Banks “Write-Down” Cash
The premise of a write-down is simple. Banks are recognizing that their ‘assets’ aren’t as valuable as it says they are in their accounting books.
Here’s an example:
Suppose a bank lent out $500,000 to a buyer looking to purchase a home in 2007, based on the home’s underlying value of $550,000. The buyer himself put up the extra $50,000 up front.
But when credit dried up and home prices dropped, the home’s current market value fell to around $400,000. That means the mortgage is ‘underwater’ by $100,000.
If the homeowner tried to sell the house at this point, the bank would be down about 20%. But the buyer would lose 100% of that $50,000 he paid for the house. The buyer could NOT recover his portion of the payment unless home prices suddenly recovered. (Unlikely in the last couple years.)
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When the banking crisis first unfolded in 2007 and 2008, ‘mark-to-market’ rules required that financial institutions record any adjustments they made to their books to account for the current state of the market.
If markets were going up, it would mean that the loans would look safer and safer… if the property became worth $750,000, the loan-to-value would fall.
But the opposite occurred — and those rules were suspended. A bank can currently leave the value of its loans on the books. They no longer have to account for any adjustments. So they can overstate their financial health. They can pretend to be improving.
So the fact that banks are taking loan losses tells us one major thing: The banks have to record these losses because the homes are being transferred, either through sales, short sales, or foreclosures.
The facts are simple: consumer spending is contracting, Americans’ outstanding credit card debt has declined by $90 billion in 2009 (about $1,900 per household), and retail stores reported a surge in cash transactions and a decline in credit card use.
That means that while government is expanding its balance sheet with credit, average people are withdrawing gradually from the excessive debts they’ve accumulated in recent years.
This deflationary trend on the consumer side is bad for anyone who makes money by lending — i.e., the banks. So, investing in banks— especially considering their run-up in the past 10 months — seems like a sucker’s bet to me.
Why? Because the banks know there’s trouble ahead. J.P. Morgan all but admitted this on the recent earnings call. You can check out the exchange below…
“Is there anything standing in the way of raising the dividend…?”
“We really want to see a real recovery before we do that…”
In other words, “no dividends for you until we recover.”
You can always depend on the honesty of bankers, right?
I’m kind of curious what they mean by real recovery, as most statements from big bankers of late has been one of lackadaisical recovery and the return to that ever-so-vague word: stabilization.
Brother, Can You Spare $200 Trillion?
Of course, the grand implication is that the recovery we see now is only a façade for what is really happening.
So what are the two worst banks out there now?
Personally, I’d like to award that distinction to J.P. Morgan (JPM) and Wells Fargo (WFC) for their large exposure to derivatives and junk-quality real estate loans.
It looks like these two big banks will need to go groveling back to the government for more liquidity. Especially J.P. Morgan, whose derivative exposure runs into the trillions of dollars.
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To find out more information on the strongest and weakest banks out there, become a GGIS Paid subscriber and you’ll get our free report with over 200 banks on the strongest and weakest list. See if your bank is on the list!
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But there’s a more important factor to consider. Check with your local bank to determine its financial health. While your assets are protected by the FDIC up to $250,000 (yeah right), a bank failure is still an inconvenience and the FDIC does NOT protect all bank assets.
One website I’ve found helpful in tracking bank’s health is: “Become a GGIS Subscriber for the info.”
This site lets you search by state and bank name. Several stats about the banks are available in an easy-to-read format, and any given bank’s health is compared to the national average.
By the way, the headquarters for major banks aren’t always where you’d think they’re located. For example, Citigroup’s headquarters aren’t in New York. They’re in Las Vegas.
Sounds like they’re exactly where they’re supposed to be.
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Until the next time!
Asante Sana (Thanks)
Gary Gray
Tax & Financial Consultant, RFC
G&G Associates
757-251-0174 office
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"Your mind is like a parachute, it only works when it is open."
C. Brown
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