Will The Bank Stocks Soar?
We all remember what happened the last time Treasury Secretary Geithner presented a bailout plan for the banks. The Dow plunged 380 points. It was a brutal, month long, downtrend to decade old lows. Before it was all over, the blue chip index had come within spitting distance of 6,500 and lost 21% of its value.
Why did the market tank?
Investors were spooked by the plan’s glaring lack of details. To make matters worse, Geithner appeared unsure of himself and ill at ease when presenting the plan. Fearful the financial system might actually collapse, investors began pulling money out of the market as fast as possible.
The prodigal son returns!
Geithner’s second act on Wall Street was received with much more enthusiasm. The Dow jumped close to 500 points for a one day gain of almost 7%. A much needed up day to keep a fledgling two week rally alive.
What’s different this time around?
You guessed it. The plan provides specific details. Investors need details so they can plan their trading strategies. There’s nothing investors dislike more than uncertainty. But, I digress.
The premise underlying the plan hasn’t changed.
The government will partner with private investors to purchase toxic mortgage assets from the banks. The purpose is to get these assets off bank balance sheets so they can recapitalize and start lending again. Before we look at the details, let’s review the problem the plan is trying to solve.
Many banks are on the verge of failing.
The nation’s banks own $1-$2 trillion dollars worth of difficult to price mortgage assets. The banks value these assets at almost their face value. But, investors are only willing to pay anywhere from 30 to 60 cents on the dollar for them. If the assets are really worth only 40% to 70% of their full value, many of the banks are actually insolvent. (That’s the doomsday scenario.)
But wait there’s more.
Due to the uncertainty about their capital position, banks have virtually stopped making loans. You might have experienced this yourself. It’s almost impossible (even if you have good credit) to get financing to buy a car, pay for college, run a small business, or buy a home. This is a catastrophic situation for our economy.
Credit is the lubricant that enables our economic machine to run smoothly.
If the banks don’t start lending again soon we’ll see a longer and deeper recession. More jobs will be lost. More homes will be foreclosed. More businesses will fail. And, the market will surely plummet.
Here’s how Geithner’s plan will try to resolve the crisis.
The government will partner with various private investors to buy $1 trillion of toxic mortgage assets from the banks. The assets will be divided up into separate pools which FDIC will auction off to the highest bidder. The pools will then be managed by the private investors with oversight from FDIC.
The idea is to create a market that will provide fair prices for these “troubled” assets. This way banks can finally get them off their books without having to write off their full value.
The really interesting part is how the assets will be paid for.
Treasury will pony up $75 to $100 billion of the remaining bailout funds to match investments from private investors. For every $100 in mortgage assets purchased, private investors will put up $7 and the government will match with $7. The rest will be covered by non-recourse loans provided by the Fed and FDIC.
In other words, private investors will bear just 7% of the risk while the government covers the rest.
As you can imagine, asset managers, hedge funds, and private equity investors are very excited about the plan. And, why not? Under its terms, they have minimal downside risk and unlimited upside potential.
How can we as investors profit from Geithner’s plan?
One way is to buy shares of the major banks like Bank of America (BAC), Citigroup (C), JP Morgan Chase (JPM), or Wells Fargo (WFC).
These stocks could soar from highly depressed levels caused by the crisis.
Suppose the banks can sell the assets near their current marked-to-market value. The banks would show a profit and replace the toxic assets with new capital. They could then use this capital to repay their TARP loans. This would inspire confidence and attract new investors to the shares.
Unfortunately, this is not likely to happen.
It’s hard to imagine any private investor submitting bids close to current marks. Even with government backing, these guys don’t want to overpay. If they participate in the program, they’re going to try to make a big profit.
The bank stocks might get a bit of a boost from clearing some assets off their books. But, they still have a long road ahead to rebuilding their balance sheets.
Another way to trade this situation is to buy shares in private equity firms.
These savvy investors may very well pick up valuable assets at bargain prices. The banks could decide it’s better to take losses now in order to move the assets off their books.
If the government is right and the assets are worth much more than their current market value, private equity firms stand to rake in huge profits from their investments. And, if the assets really are worthless, the government takes the hit.
Two private equity firms to take a look at are Blackstone Group (BX) and Fortress Investment Group (FIG). Both stocks soared after the bank bailout plan was unveiled. BX is up 30% and FIG is up 71%.
Don’t let bank CEOs, hedge funds, and private equity firms be the only ones to profit from the bailout. Climb aboard the private equity gravy train and grab a slice of these profits for yourself.
Category: Stocks
