Thursday, May 17, 2012

Bank Bears Reawaken

Until late last week, the group which led the S&P 500 in gains for the year so far was the financial sector. This group of stocks was up nearly 15 percent for the year, nearly double the gain made by the broader market. But financial stocks fell sharply on Friday after JPMorgan (NYSE: JPM) stated it had made “egregious mistakes” and incurred significant ($2 billion) mark-to-market losses in credit derivatives since the end of March. And the company warned the losses “could get worse”.

This was terrible news for the shareholders of any of the investment banks as worries spread across the sector about the strength of banks' balance sheets and Wall Street's business model. Other stocks to suffer in the selloff include the investment bank poster child Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), Morgan Stanley (NYSE: MS) and Bank of America (NYSE: BAC).

Broad investor sentiment to the JPMorgan announcement was summed up by Oliver Pursche, portfolio manager at Gary Goldberg Financial Services, “It is a reminder that when it comes to the financial sector, investors still have to be very guarded. There are still just too many uncertainties, way too many gimmicks within those balance sheets.”

Mr. Pursche is likely correct. Look at JPMorgan's $2 billion loss. Its 'chief investment office' is just a fancy name for a proprietary trading desk for the company. Since it is located in London, a question should immediately pop into investors' mind...was JPMorgan trading with their money or customers' money?

London is the place to be if you want to use other people's money to make money for yourself. Just think back to the MF Global scandal. They used a process called 're-hypothecation', which occurs when banks re-use the collateral posted by clients such as hedge funds to back the bank's own trades and borrowing. London is the center of re-hypothecated trades on the planet since there is no limit on the amount of client assets that can be re-hypothecated even if the client had an agreement with the bank that includes a ban on such practices.

Moving away from the murky world of shadow banking, the investment banks have another and more immediate worry on their hands – credit downgrades from the rating agencies.

Late on Friday, Fitch Ratings did downgrade JPMorgan's rating from AA- down to A+ and placed the bank on 'rating watch negative'. Standard & Poor's followed up by changing its outlook on the bank to 'negative' also.

A major talking point on Wall Street among the investment banks has been the recently announced Moody's upcoming review of the banks which is scheduled to be issued in June. Moody's had already put Morgan Stanley and several other banks on review for a downgrade in February. It is believed that JPMorgen may face as much as a three notch slide in its ratings while other banks including Citigroup and Goldman Sachs have a two-notch slide looming over them. Bank of America has the potential for a one-notch slide in its rating.

Morgan Stanley said last Monday that if such an event occurs, it would have to pony up another $7.2 billion in collateral if its rating was changed by Moody's and Standard and Poor's. That is more than an 50 percent increase from its last estimate. Other investment banks, if downgraded, will also face raised borrowing costs and increases in required collateral.

For a long time, the stock market has ignored the problems with the major banks which never really went away from the 2008 financial crisis. But that may be changing now. It looks as if the good times for the banks and their investors are over and it may turn out to be a long, hot summer for the sector.

This article was originally writtern for the Motley Fool Blog Network. Be sure to read my daily articles for the Motley Fool at


  1. I cannot believe that something like this can happen in the united states of america. We now live in a nation where the type of type of financial shenanigans occuring on a daily basis would only be thought of as happening in third world countries maybe south america. But now their happening here. I don"t believe that we are seeing so much of a big increase in the financial shenanigans today but less enforcment of violations of securities laws by the SEC. I can remember back in the nineteen eighities when almost two thirds of all the savings and loans were taken over by the FDIC the arm of the federal government that is suppose to regulate banks and other financial institutions. Their were thousands of persons charged with all sorts of crimes during and after the savings and loan debacle. I cannot believe that not anyone on wall street has been charged with any type of crime after the financial crisis of two thousand eight and two thousand nine that just about brought down the whole financial system.

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  3. I would not touch a bank stock with a ten foot pole.