Will Foreclosure-Gate Bust The Banks?

| October 19, 2010 | 0 Comments

I’m sure you’ve heard this old Wall Street saying… Buy the rumor and sell the news.

We’ll often see traders buy a stock when they expect good news in the future… Buy the rumor.  Then once the news is released – the catalyst is gone – and they sell… Sell the news.  It causes the stock to move in the opposite direction of what everyone is expecting.

Think of it this way – the market prices in change before it occurs.

So, what happens when the markets are expecting bad news?

It’s an opportunity to sell the rumor and buy the news!

Simply stated, the expectation of bad news in the future will drive down a stock’s price.  But once the event takes place… It’s a great time to buy an out of favor stock being mispriced by the market.

And right now the banking industry is a prime candidate for a “sell the rumor and buy the news” trade!

Let’s take a closer look…

In the past few weeks, banks have seen some ugly news come to light. They’re accused of losing loan documents, lying on court records, and a number of other shady (possibly fraudulent?) business practices.

Clearly, banks have badly mismanaged the foreclosure process.  It’s brought down a firestorm of criticism from state and federal authorities.

Now, state attorneys general are launching investigations into the foreclosure practices of the major loan servicers.  It’s caused many banks to temporarily halt foreclosures until the investigation is complete.

It’s being rumored it could cost the banks anywhere from a few billion to hundreds of billions to get this mess straightened out.

This rumor is a weight around the neck of the banking sector.  But in the end, the rumors will be much worse than the reality.

Here’s why…

The overwhelming majority of foreclosures are legitimate… If the borrower isn’t paying their mortgage then the owner of the mortgage has the right to foreclose on the property.  Period.  End of story.

Even if paperwork is being signed by workers who don’t know what they’re signing… it doesn’t change the facts.  The bank still has the right to foreclose on the property.

And even if it costs the banks a few billion dollars to settle the lawsuits it’s still a good deal.

Sure, the banks could have staffed their foreclosure department with high paid knowledgeable employees.  They could have avoided this mess. But they chose not to because of the cost.

Look, bank management knew hiring cheap workers with no experience could result in errors.  And costly legal bills.  But they chose this route because in the long run, even with the lawsuits, this is the cheapest alternative.

When I was working in the banking industry I saw decisions like this being made all the time. (It’s one reason I no longer work in the industry…) We made sure we didn’t “throw good money after bad”.

It’s like when a company knows of potential problem with a product.  But instead of a full-fledged recall they keep quiet and settle individual lawsuits.  They choose this path because in the end it will cost them less money to settle lawsuits than to issue a recall.

Sorry to say, but this isn’t fairytale land where it’s all gumdrops and lollipops… This was a cold and calculated business decision.  And in the end, having a horde of unknowledgeable workers rubber stamping foreclosure paperwork will be good to the banks bottom line.

You decide…

Is government really going to allow the same banks they just got done bailing out to be toppled by this mess?

Or, are politicians playing to the masses by blasting the banks as mid-term elections approach?

This is one rumor I’m selling… Expect bank stocks to fall for a short while. Then once the news is out, the banks are going to be a great buy.

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Category: Stocks

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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