The Banks: Sell, Short, Stay Away

I have been urging everyone who would listen to avoid various classes of banks, starting with the some small regionals in February 2007 to the big guys in October of that same year. The reason? I can read and do my sums. Forget all the noise - the big banks are insolvent or close to it, the toxic assets at the root of this problem are not going away anytime soon because the banks are not going to get the help they do not deserve but we all need. Thank you, AIG et al.

This week's action by the Fed, expanding its balance sheet more than a trillion dollars, and this week's action by Congress, disgusting but truly democratic, is proof the problem of toxic assets cannot be solved for both financial and political reasons. And Bernanke and Geithner both know this, and neither is as politically savvy as Barney Frank, who certainly knows this.

The big banks are insolvent - oh, they may have the technically correct amount of Tier One capital, and their leverage is decreasing, and they have operating profits, and all that nice stuff - you can read the gory details and the puffed press releases and statements from Citigroup, Bank of America and Wells Fargo elsewhere. But they also have massive amounts of toxic assets that are not just illiquid but bad, getting worse and destined to get, as Dickens liked to write "worser and worser" in the coming months. Citi alone had more than $1.2 trillion (as of November 2008) in off-balance sheet assets - and they are off balance sheet for a reason. JP Morgan and Wells Fargo have more than $120 billion in option ARMs that have absolutely incredible default rates - some analysts predict these rates will climb to over 50% in the next 30 months) - and they can write these down when they are impaired as they were originated by banks bought by Wells and JP Morgan. A good deal of Tier One capital will be changed as the assets ratings are changed as they deteriorate. And some banks - notably Citi - have a lot of "tangible equity" in the form of deferred tax losses. Give me a break. So, from a fundamental point of view, they are bust.

Back to the point at hand. Can Uncle Sam help? With the AIG mess in full bloom, Treasury now must scale down or abandon efforts to raise the capital they need to fix the banks - I believe this is $1.5-$2.0 trillion - and the conditions attached to these funds are now going to be so onerous the cretins now running the banks will refuse the money, try to tough out the crisis and make things much worse. I believe this is why the Fed acted so quickly and strongly this week, expanding their balance sheet by more than a trillion in a surprise move. They now believe Treasury can do little more. The tin ear shown by the executives on Wall Street is astounding - more on that in a different piece - and reflects the difference in leadership of partnerships, where people are risking and managing their own money, the model of the 1980s and early 1990s, with that of publicly held companies, where people play God with other people's money. And tend to act like it.

The Congressional reaction is disgusting - but we live in a democracy, wrinkles and all. I remember a line from a Law & Order - Jack McCoy explaining why society wants and often needs the death penalty - it is to "keep the mob at bay and do the mob's work for them" or something to that effect. Ditto for Congressional reaction to the AIG and other bonuses. And to that point, until the people get their revenge through Congress the banks will not get any reasonable amount of money without unduly tight restrictions governing their use and the management of the institution receiving the funds.

I mentioned Barney Frank earlier because everyone agrees, enemies and friends alike, he is by far the smartest person on the Hill. And he is supporting the bandwagon for bonus revenge - which means he knows this is necessary, long term, for democracy to play itself out. Bottom line: whatever help the banks needed and could expect from Washington is going to be smaller and more difficult to use. The only possible exception will be if Geithner purposely queers the stress tests - a 50/50 probability right now.

What about the toxic asset purchase plan? Too little money - there is a growing sense their will be federal strings to getting money or guarantees, how many hedge funds so you think will participate with vigor? It is, simply put, a mess.

So, forget the short term action - the big guys are a wreck and won't get help soon. Not from clean capital injections, not from simple toxic asset purchase plans. Wait until next year when they break up, their assets are sold here and there. That may be the time to buy. More on that later as well.