US Banking Crisis -- Market Fundamentals (13).
The recent meltdown of the US banking industry is the single most disruptive force that will likely trigger a worldwide recession and a prolonged decline of the stock market. Lets see if we can learn something from the market fundamentals.
Financial Stocks Down
Since June 07, financial stocks started to decline. They reached a low point by June 08. The following shows the carnage: Citigroup: from $55 to $14, Bank of America: $55 to $20, JP Morgan Chase: $55 to $30, Morgan Stanley: $90 to $12, and Goldman Sachs: $250 to $90. Since then, the stocks have rebounded somewhat.
Two Main Causes
The first one is the lowering of interest rate by the Federal Reserve. For fear of a recession induced by the dotcom bust and the 9/11 terrorist attack, the Fed continued to lower interest rate from 6.50 in May 2000 to 1.75 in September 2004, then adjusted it gradually to 2.00 by April 2008. This has created an unprecedented flow of easy money for the banks to lend.
The other main cause is the absence of supervision by the Bush Administration because they believe that the market will solve all problems of society. One thing they could not see is that greed knows no limits. The bankers continued to lend and lend in order to maximize profits.
The best place for banks to lend is real estate because it is the most tangible collateral. Thus the easy money fueled the housing boom. When housing prices continued to rise every year, the bankers invented the sub-prime loans where consumers were seduced with very low interest rates for the first few years, then the rates would be adjusted back to normal. In a housing boom, it makes sense for the consumers to take a loan to buy a house regardless, then sell the house for a profit before the rate adjustment comes. What the banks failed to see is that when they lend billions and billions to homebuyers, it will become their big problem if too many homebuyers default at the rate adjustment time within a few years.
Consequence
The result is an ugly mess of bank failures and billions of mortgage write downs for the banks. Increasing mortgage defaults also cause housing prices to drop. Business failures occur everyday but bank failures are quite different. They result in contraction of credits on which all businesses depend for daily operations, especially the automobile industry. Besides worrying about the next paychecks, people also wonder if their money is safe in the bank. Thus it leads to a crisis of confidence that can easily bring down the whole capitalist system. No wonder the US Congress was so scared to pass a massive $700 billion bailout bill within a week. Will it work? It depends on how big is the mortgage problem that nobody knows.
Uncertainties
The following may happen in the next few months:
•More banks may fail in US and overseas.
•The US may lead the world into a deep recession.
•The stock market may continue a prolonged broad decline.
Hopes
The massive US bailout may work. At least it draws a line of defense to protect the big banks like Citigroup, Bank of America, JP Morgan Chase, and Wachovia (to be purchased by Citigroup or Wells Fargo brokered by US government). The rest will be left to die or merge with other banks.
Where is the Bottom?
The major bank stocks appeared to have touched a bottom in July 2008 when Citigroup reached $13, BankAmerica $18, JP Morgan Chase $29, and Wells Fargo $20. They have all sprung back quickly since then. The government bailout may have prevented them from falling further. But then, who knows? We have only seen the fact that they briefly touched a bottom. If there are more banks collapsing in the next few months, the mood of the market will depress these stocks further.
If you have surplus cash and are willing to take risks, the major banks mentioned above are good candidates for a rebound. However, never try to guess the bottom. You have to see the bottom to believe it. We have seen it once recently but it may be a mirage. If the economy continues to worsen, there will be another bottom to watch. I remember during a prior downturn around 1992, CitiBank stayed at $9 for quite a while.
For further information, please email to stockfessor@comcast.net
<< Back to article
