Bank Stocks = Lepers

11/17/2011 11:00 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Wall Street’s accounting is now widely doubted, as investors fret about the credit risks on and off the balance sheet, writes senior editor Igor Greenwald.

This market will never be confused with a crowded theater. These days, it’s more of a peep show frequented by a handful of men in raincoats.

But someone yelled the equivalent of “Fire!” into the murk yesterday afternoon, and boy, was there a rush out the door.

In truth, Fitch Ratings merely nodded in the direction of the towering European inferno, a disaster apparent to everyone. Still, the foreboding title alone: “US Banks—European Exposure” cost the Dow a quick 200 points and kicked all the Wall Street stocks down another flight of stairs.

It could only have been the headline, because the gist from Fitch was that the exposure is manageable unless things got worse, or if the banks couldn’t collect on mammoth hedges of their gargantuan bets, which might amount to such and such...but then who really knows? Fitch rates the industry’s credit outlook stable for however long we have until things do get worse.

Of course, Fitch is just one of several blind credit analysts in the room, each trying to size up the elephant of the banks’ risk in a European crackup. Should we count gross exposure or net? What are the chances some of the counterparties won’t make good? And if they don’t, how much can we really trust their collateral?

It doesn’t help that the banks are playing hide-and-seek, revealing mostly their net exposure, but not the gross, and offering no details on their counterparty risk beyond the bland assurances that they’ve been minimized.

The bankrupt MF Global carried billions of European sovereign exposure off the balance sheet, exposure it only owned up to under pressure from regulators just as the death spiral was commencing.

That’s naturally led to questions about similar off-the-balance-sheet risks at bigger banks, questions those banks have so far not answered.

That could be one reason that JP Morgan (JPM), Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS) are all trading at a discount of at least 30% to reported book value.

Few investors trust those books these days. US accounting rules have been so manipulated and gamed by the banking industry they’re supposed to police that statements based on those rules are now routinely discounted as propaganda.

No wonder industry insiders are calling banking “a black box” that’s currently uninvestable.

New regulations may be partly to blame, but those in place already and others still being debated are coming precisely because the industry has failed so spectacularly. The massive debt deleveraging now taking place means that the banks will remain for years to come a source of risk and weakness for the rest of the economy.

They are those peep-show regulars, so perhaps it would be best not to know what they are wearing under those raincoats. But unless they shed those and prove they’re decent underneath, no one is going to want to get too close. And that’s a real problem when your business model is gambling with other people’s money.

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