Monday, August 04, 2008

Where Did The Perception That Banks Were Good Investments Come From?

There is no question that if you look at banks historically you can see the factors that investors promote when looking for a "good" investment. My friend that encouraged me to invest at the time was waiting for a huge market correction. That was back in 2006 and he was already more then half cash. One that he mentioned he wanted to pick up was HSBC, and his price was in the $65 range. The reasons, years of growing dividend, expanding into emerging economies, steady in their years of showing growth, etc. There is a list somewhere, I am sure.

He also talked about how dividend stocks tend to bounce back better after a downturn, at least that's what happened with the last down turn.

There is no question that banks had a very good run, but I doubt what was known to be true historically is going continue to be true moving forward.

When I look at where the increasing profits came from a see a sector that will have years upon years of disappointment to investors that fail to think this through.

You have the maestro idiot who for more than a generation gradually stepped interest rates down. So, what exactly does that do for bank profits? Consider that the dollar value of loans have been increasing over the years much more then wages. Banks are increasing their profits as that dollar value of loans increased. This has gone on since the 80s. It has enabled some troubled borrowers to refinance at lower rates and avoid the messy businesses of defaults, and of course there is an enormous fee that goes with this. Heck, there were borrowers that weren't in trouble that refinanced and just paid the penalty. I did so twice as it was in my interest to do so, and there was up to 3 months interest penalty on my mortgage each time.

Banks also added those fancy securitization products which they made a bundle on.

Well, now that there is a rate reversal in progres, so just what are all the ways that banks will lose out on in terms of how they were increasing their profits?

Loans aren't going to be getting bigger. Wages will finally have to catch up. Just how many years do you think this will take? A decade or two would not surprise me. Moving forward banks will have decreasing values of loans. Trying to increase profits through increasing rate spreads will simply increase this effect. So years of declining loan values is a given.

And, now that interest rates pretty much went as low as they could go, well, just how are those troubled borrowers going to refinance? I suppose those with massive credit card debt at high rates might be able to, but what about troubled mortgage borrowers? Or over extended big car loan borrowers? Now some of the defaults that were traditionally avoided by refinancing aren't going to be avoided. I suspect it will be years of higher defaults then historically. There will be a large wave to start and then a much higher steady stream as life's challenges hit people that were doing their best but had no room for those life's challenges -- relationship break-up, job loss, unexpected pregnancy, illness, natural disaster and so on... So, years of higher defaults for banks is a given.

You think the securitization of debt market is ever going to be as profitable again? I don't. So years of reduced profits from secutitization is a given.

Then of course there is the massive dilution of stock as banks work to raise capital. So, you have this declining profit environment on this growing equity base.

It seems to me that there is going to be a move to less debt in this environment, so not only will loan values be smaller, people will go back to the "old fashioned" way of making purchases, saving a good portion before borrowing. If you think it through what the stepping down of rates did to housing, well, it increased the loan amount that people qualified for and the responsible saver who wanted 20 or 25% down was forever finding that out of their reach. It lead to the masses jumping in early in terms of saving for a down payment because you could never earn in wages what you'd lose in equity as home values went up. They watched the market go up for 2-3 years they were wanting to buy and finally jumped in. It is what happens to young people.

Generations just young enough to miss this massive bubble will learn from the financial hardships they see around them. Many will wait and they will save for a proper down payment.

So, where do I see banks? I think loan values will cut in half and raising equity to cover losses will double the number of shares out there.

I can't see the business sector of banks doing much better.

And then there is the investment side of it. I think so many people are going to be hit hard by the markets there will be a trend back to safer investments. My idiot investment advisor argued with me over an investment I wanted to make and then I was charged $400 on the one trade. This garbage is already on the decline. Look at all the competition for $10 trades now.

So, no kidding banks were a good investment. There many things happening in their favor that whoever was running them would have to be worse then Bush to screw it up. But now the reversal comes and it isn't just reach a bottom and go back to business as usual. Moving forward the business environment is going to have those things that worked in banks favor working against them, and it is going be years of challenges and little opportunity for profit growth.

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