Is It Time to Buy Banks?

After processing Treasury Secretary Tim Geithner's latest plans to save our financial system, I'm tempted to buy a bank stock.

See, Mr. Market kicked my butt last year. And I want some revenge.

What better way than to be contrarian and pick up shares in the most beaten-down, toxic, left-for-dead sector this side of the homebuilders?

Why not?
It's not as if we're still worried that banks are going under. After all, the government has made it clear that the largest banks aren't going anywhere. Those that were already too big to fail only got bigger:

  • Bank of America (NYSE: BAC  ) swallowed up Countrywide and Merrill Lynch.
  • JPMorgan Chase (NYSE: JPM  ) grabbed Bear Stearns and Washington Mutual.
  • Wells Fargo (NYSE: WFC  ) took over Wachovia.

Any remaining worry that the banking behemoths would be allowed to fail has been eliminated by the second helpings of TARP love for Bank of America and Citigroup ... and possibly more on the way.

See, too much is at stake. As fellow Fool Richard Gibbons explained, the lending banks provide allows our whole economic system to operate. Without this credit, we wouldn't just be talking about the impending collapse of companies with inherent problems like General Motors (NYSE: GM  ) and Chrysler -- we'd also be talking about the possible bankruptcies of robust companies like Wal-Mart (NYSE: WMT  ) and Procter & Gamble (NYSE: PG  ) .

And we won't even get into what would happen to credit-dependent medium-sized businesses, mom-and-pop shops, and individuals.

The banks -- and the banking industry -- will definitely survive.

But what price survival?
So the banks will survive. They must. But -- and this is why temptation hasn't turned to action -- survival doesn't necessarily mean that shareholders will benefit.

Just ask the people who owned Fannie Mae, Freddie Mac, and AIG.

Yes, the government will continue to throw lifelines to the banks, but the implications for the banks and their shareholders are still undetermined. As shown by the new curbs on executive pay at companies receiving TARP funds, the government can and will make the costs of those lifelines increasingly punitive. It's no coincidence that Goldman Sachs (NYSE: GS  ) and JPMorgan suddenly want to pay back their TARP money as soon as they can.

And this may not be the end of it. Recall that the rescue of Bear Stearns last March was supposed to prevent a financial collapse. It didn't -- a year later, we're still groping for a stable plan of action.

The government has many tools at its disposal -- from the purchase of toxic assets to capital injections all the way on up to complete nationalization. And each of these options could be executed with very favorable or very unfavorable terms for the banks and their common shareholders.

Think positive?
Now, I'm a confirmed optimist, but given the government-intervention wild card, buying banks at this point is more speculation than investing.

Why? Even discounting government-related uncertainty, to invest in a bank, we must thoroughly understand the balance sheet of that bank.

And that's virtually impossible in the case of investment banks, especially now. Understanding even one derivatives contract is daunting; properly assessing the risks of a whole portfolio of derivatives contracts jacked up with leverage and swapped back and forth by mis-incentivized traders is more Einstein than Joe Investor.

Thus, I wouldn't touch shares of Goldman Sachs, despite its status as a finishing school for Treasury Secretaries. And if I wouldn't touch Goldman, I certainly wouldn't touch Morgan Stanley.

But even when we're talking about banks that have stuck to their commercial banking roots, avoided risky megamergers, and seemed to navigate the subprime debacle well -- like BB&T and US Bancorp -- we can't be sure.

Don't believe that the "healthy" banks are healthy just because nothing bad has come out yet. We've seen again and again in this crisis that everything is fine until it isn't.

Talking us off the ledge
So I would advise against buying a bank stock unless you have three things: particular insight into bank balance sheets, an unshakable faith in that bank’s management, and comfort speculating on the final form of the government bailout initiatives.

But I understand why it's tempting. When I see age-old companies with dividend yields hovering around 12.5%, I salivate. In the end, though, I'd rather find attractive yields attached to excellent companies that aren't living and dying at the whim of the government.

When the average stock is selling for half off, why take the extra risk by buying a bank stock? If you're looking for companies selling at attractive prices (with sustainable dividends to boot), I invite you to view our Motley Fool Income Investor team's recommendations. A 30-day trial is free. Just click here to get started.

Anand Chokkavelu still owns long-held shares of Citigroup (sigh). JPMorgan Chase, BB&T, and US Bancorp are Motley Fool Income Investor selections. Wal-Mart is an Inside Value recommendation. The Fool owns shares of Procter & Gamble. The Fool has a disclosure policy.


Read/Post Comments (38) | Recommend This Article (163)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 24, 2009, at 3:21 PM, MadStabber wrote:

    Or you could buy the FAS basket.

  • Report this Comment On February 24, 2009, at 5:35 PM, Aujla007 wrote:

    well said

  • Report this Comment On February 24, 2009, at 5:52 PM, sentinelbrit wrote:

    Not to own any banks in one's portfolio at this stage of the game is perhaps more risky than being naked. You're right, it's impossible to know the risks within a bank's balance sheet - heck senior management didn't know! However, let's see what we do know: bank stocks are at historically low levels - they have been crushed. The latest bout of selling has been based on fear of the unknown - and in particular the fear of nationalization. But that fear now looks overdone (hence the rally today). In another case, JPM reported that so far in the first quarter they are "solidly profitable". Banks are still doing business - today I received in the mail a letter from BAC offering me a loan. I also noticed that ML is advertising its services. In the face of the economy and collapse in stock prices we forget that these banks are still doing business and marketing their services. Sure Lewis is on a mission to prevent BAC being nationalized but he has said some pretty postive things about the bank's operations. My guess is that the bank will turn in an operating profit this quarter - and this is supposed a basket case.

    Locking away some banks shares now will pay off in coming years.

  • Report this Comment On February 24, 2009, at 6:37 PM, Dart65GTConv wrote:

    My high school friend from China' family ounce were wealthy land owner's in there homeland. Today they rebuilt their lives and live a healthy hard working existence here. My other friend from India who worked hard after taking this leap to USA has also worked day and night to build a nice life. All I can say is a pattern all to familiar is unfolding inside the borders of the last refuge of opportunity for the motivated common people.

  • Report this Comment On February 24, 2009, at 7:22 PM, rutumbher13 wrote:

    Dart65, what are you talking about. I get it that people have moved here from other countries. What does that have to do with buying bank stocks. I think other countries are trying to clean up their corrupt ways..modeling after the greatest of all nations. In that clean up lies a bigger opportunity for people who still live there. For the past couple of years the motivated common person is getting creamed by loss of jobs and crazy mortgages in the US. On the matter of the banking system, if the banks are gone so is everything else. Once the correction takes place the financial stocks are probably the best stocks to own. Once again if there is no banking...there is no financing ...and everything else is caput!

  • Report this Comment On February 24, 2009, at 7:28 PM, Subedu wrote:

    If you are anxious to get into financials you should buy AIG, after all they handle the trust fund for Congress and you know they aren't about to let that one go down the tube.

  • Report this Comment On February 24, 2009, at 7:37 PM, srpfool wrote:

    Dart,

    Perhaps your chinese friend should have been better connected. Did no one tell you that the current financial system meltdown is the result of a plot by China?

    http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?curr...

    Hahaha

  • Report this Comment On February 24, 2009, at 7:38 PM, 7footmoose wrote:

    at some point the banks will become a very good investment, determining when to invest in them is a crap shoot, there may well be several more years of pain in the financial industry BUT it will come back in some form because commerce in this country cannot go on without a functioning financial system and ultimately even the Naysayers and Dr Doom will have to understand that todays greatest obstacle to recovery is the lack of confidence in the financial system

  • Report this Comment On February 24, 2009, at 7:40 PM, Fliujniligui wrote:

    Not only am I taking massive risk on banks, I do on banks not so or not at all heard about in medias. Those who seems to have been insightful, conservative but opportunist and growth oriented well before the crisis start. Likes of Allied Irish Banks, Deutsche Bank. Toronto Dominion (Canada is the new Holy Grail), ING Groep probably represent better opportunity than BAC and C, and their stock price levels are so low. For the price of an investment in 1 bank one year ago, you can buy now all of these 4 banks for less. This bodes well for the outcome in 20 years.

  • Report this Comment On February 24, 2009, at 7:45 PM, rasdj wrote:

    GE's still around. Big banks should be fine.

  • Report this Comment On February 24, 2009, at 8:34 PM, Greenyards wrote:

    I suggest Allied Irish is not a sensible investment any more than a bank in Iceland.

    Royal bank of Scotland has around 200,000 employees around the globe. It has raised 27B ($34B)billion pounds by rights issues and 3 or so more by asset sales. Uk Govt looks as if it has a toxic debt insurance scheme so that it can dump $250Billion less good ( or toxic) assets. It also plans to set up new division for riskier assets and assets which may be sold. This is one of the big boys and has probably done more to get its house in order than any of the big banks.

    Last year had £10 billion Profits (£11B if ABN Ambro added) Even shorn of some 2010 might show £6 -7B It is currently at a PER of less than 1. It is 58 % owned by UK Govt but it is just possible that may be reduced when Govt Preference shares are converted into a Non voting share. Obviously it is in the interests of UK Govt to get value back into the shares and it is holding all the control cards right now. UK Govt can make a massive profit on sale of the shares back to the private sector. How would a fixed sanitised safe bank at a PE of 5 with a good div resuming in 2010 at a third of the price the govt paid. ( It dropped from £0.65 pounds since at one point it looked as if further dilution was afoot )

    RBS has ADR 's and for a global bank the price , despite the fashionable wailing - is an obbvious solid supernormally cheap share

  • Report this Comment On February 24, 2009, at 8:50 PM, jesse2159 wrote:

    Sorry, but, no thanks. I still cannot find any bottom to their losses and transparancy isn't something that comes easily to them. One estimate is that Citi has many billions more in highly leveraged "assets" (using a kind term) that may not be paid back for decades. Citi isn't returning to profit any time soon, if ever, so how do you judge what it's really worth? Bank of America isn't as badly off, but it too has many downsides and there is very little that they can do when they have too many bad loans that will be required to be cleaned up first, at very steep losses.

  • Report this Comment On February 24, 2009, at 9:11 PM, oceantraveller wrote:

    Americans are learning to save big.

    Where are they going to save their money?Bank of China?

    Banks do not need expensive research compare to other industries.

    Do not require test beds for future products.

    Their buildings and lot locations are more strategic than Macdonalds.

    Do not require thousand of employees for reeducation and retraining if the products require new innovations.

    One of the oldest businesses if not the oldest.

  • Report this Comment On February 24, 2009, at 9:22 PM, JibJabs wrote:

    I hold faith and stock in MTB.

  • Report this Comment On February 24, 2009, at 10:03 PM, dibble905 wrote:

    Here's the thing. When will you truly know the riskyness of a bank? Lets say that there are only Bank A - Z in this world. Bank B, D, and S fail before the economy starts to turn around. Does this make Bank A, which survived, any less risky than Bank B, D, or S? It could have been pure luck at play here.

    If your reasoning for not investing in a bank is the inherent risk, a wait and see approach won't alleviate anything. In fact, you're more likely to purchase the bank stocks which seem healthy at high/recovered prices only to find out months later that they were on the brink of collapse. Buying at a higher price only means there's more to fall in that case.

    So based on that argument, you should never be buying bank stocks.

    Good news is, you can find some hidden gems. Banks with a history of sitting on cash with growth by acquisitions at pennies on the dollar during tough times like these but never seem to grow too much during expansions. They wait and wait and wait until boom - they come out firing on all cylinders when everyone else is folding back. The contrarian banks as you will.

  • Report this Comment On February 24, 2009, at 10:12 PM, courtneTHEgreat wrote:

    I still say that the key indicator, the DOW, will hit 6600 before we can say falling lower is history. But for now, I can say FOOL is right (I cannot believe that...). BOA will play with 5.00 to 6.50 and if it breaks 7.00 before the earnings period... be cautious.

    Let's not be silly. If the banks turn a profit, things are great... If homebuyers start buying because banks start lending, things are great. If not, we have more work to do. Keep in your mind, "do we really like Uncle SAM?" Why work if Uncle hands me a check when I cry?

    So, watch BOA and C jump1.5 to 2 points... and ride that channel! If they report good news... it is the beginning to the end.

    courtne-the-Great & Zee...

  • Report this Comment On February 25, 2009, at 6:43 AM, dlcapo wrote:

    The time to buy a bank was the day BofA hit $2.30. I missed that one but sure would like another shot at it.

  • Report this Comment On February 25, 2009, at 9:51 AM, TMFBomb wrote:

    I've gotten a few questions on investing in a financial ETF like XLF. Buying the market as a whole (including banks) is one thing, but buying a financial ETF is another. A sector-specific ETF is great when you have confidence in the sector, but don't have confidence picking the winners and losers in that sector. If I had to choose between an individual bank and XLF, I'd choose XLF. Banking will survive...I just can't assess how much pain is left on their balance sheets or how the govt is going to act.

  • Report this Comment On February 25, 2009, at 10:43 AM, GSmith42 wrote:

    Might I suggest that you look at buying Canadian banks. They are the most solid in the world according to the IMF. They comply with much stricter requirements for cash reserves and have barely been touched by the mortgage problems and derivatives. You already know some of them in your neighbourhood by different names - TD - Toronto Dominion. RBC - Royal Bank of Canada. Do your own research - some of them have been beaten down lately by the general market sentiment even though they are still paying a healthy dividend - and see if you find value. Their quarterlly reports are starting to come out today.

  • Report this Comment On February 25, 2009, at 11:19 AM, Langalier wrote:

    My thoughts exactly GSmith... All we have to do now is convince Cramer.

    Lang.

  • Report this Comment On February 25, 2009, at 1:40 PM, max12345 wrote:

    Fannie Mae and Freddie Mac are now trading at 50 cents per share. A couple of years back they were trading at 30 dollars a share. (60 times as much)

    Suppose that in 5 years -by which time property markets in the U.S. will more less have come back- they will only be trading at 5 to 10 dollars per share. That would be a tenfold to twenty- fold increase in 5 years.

    Of course there is also the possibility that they'll be trading at less than nickel in five years. (a tenfold drop) Which do you think is more likely given that the U.S. government now stands fully behind them?

    And who was that guy (some pauper or some homeless person somewhere maybe?) who had said that "when others are fearful I get greedy and when they are greedy I get fearful"? Of course that silly fellow too could be wrong.

    But people are about as fearful as can be of Fannie Mae and Freddie Mac right now. Who knows? They all may well be right and have every reason to stay fearful. Or maybe they will miss out on the opportunity of their lifetime. Personally I would rather lose 10K trying to make 200K than sit by and do nothing.

  • Report this Comment On February 26, 2009, at 10:06 AM, TMFBomb wrote:

    Got a question from a reader about insider buying...I would not base a buy decision on insider buying by bank executives...it's interesting information if you thoroughly trust the investing skills of the executive...but, many of them were the ones that got the banks into this mess, so I'm skeptical.

  • Report this Comment On February 26, 2009, at 4:22 PM, multi007 wrote:

    Im 30% in with BAC at 4.20. Need to recover from last years losses. Fingers crossed.

  • Report this Comment On February 27, 2009, at 1:52 AM, simonkathrein wrote:

    Gee... weren't there articles here at the beginning of 08 that the bottom was here and we should buy???

    One of my mentors taught me that you don't buy into weakness, you buy into strength. In other words, wait until the market starts into it's confirmed uptrend, and optimism is returning to the market before even thinking of buying into that banking sector.

    Or said a different way, wait until the market crosses back over it's 200 day moving average on rising bottoms and rising tops, with optimism written about in the news, before even thinking about buying back in.

    Also, if you believe Peter Schiff's ideology, or Harry Dent's ideology, then we probably won't see a bottom until 2012/2013 or so. Check out a free lecture Dent gave on you tube at:

    http://stockcapitalist.com/?p=1026

  • Report this Comment On February 27, 2009, at 2:19 PM, thenailer wrote:

    Well let me pitch in I signed up with motley and was looking at banks and they were strong on BAC so as I was looking for a bargain and was somewhat foolish as I bought in at 10.50 on the fools take and 2 days later got slammed and now u don't see it on their site well I am no longer a fool|> Liked the site just bad timing I Guess?

  • Report this Comment On February 27, 2009, at 4:37 PM, simple09 wrote:

    Hey Anand. Catchy title. Where did you get it?

  • Report this Comment On February 27, 2009, at 5:19 PM, jagmaniac wrote:

    A few months ago I followed the advice of my Banc of America advisor and bought preferred stock in Citi group, ING, and Suntrust and as of today I guess I am out more than $25K. This may not be a lot to some people but I am retired and on a fixed(?) income. I had hesitated on Citi grp but the advisor assured me that it was a safe buy. Guess I have learned to depend on no one but myself for investment advice. So beware of Bank stocks.

  • Report this Comment On February 27, 2009, at 6:10 PM, mablesleetcopino wrote:

    Banks trade at low PEs even in good times because they are highy leveraged and inherently risky, contrary to popular notions that banks are "solid".

    Warren Buffet said you can destroy a perfectly sound financial institution just by spreading rumors. That's how tenuous they are if enough capital is pulled out of them or assets devalued.

    Common stakes in even the best banks right now are risky.

  • Report this Comment On February 27, 2009, at 6:27 PM, ellebal1111 wrote:

    I've put in some of my loose money in DIREXION SHS ETF TR FINANCIAL BULL 3X SHARES (FAS) for long term...seem to be a bargain at $4.80...

  • Report this Comment On February 27, 2009, at 7:33 PM, joelcorley wrote:

    jagmaniac,

    While I'd question some of your adviser's picks, I have to ask, are you still getting the same preferred dividends? If you're on a fixed income, that should be your primary consideration - not the current market value of your investments.

    With that said, you do need to worry about your Citi group preferreds. Unless they are capital trust preferreds, the dividend WILL be suspended after they close their latest deal with the Treasury Dept.

    BTW, I've been investing in bank capital trust preferreds lately. The average share price has fallen; but I still view this class of stock a pretty good deal. It more closely resembles buying bank-issued debt; but these days the issues are trading at steep discounts to their par (face) value which can give you extremely high effective yields.

    Of course capital trust preferreds are still a bit speculative, but I think they're probably one of the safest ways to play the big banks. If the bank is "too big to fail", it suggests that the government is unlikely to pull the plug on any of the bank's creditors - even if that is still an option for the common stock holders.

    - Joel

  • Report this Comment On February 28, 2009, at 1:52 AM, emmurphy100 wrote:

    WHAT is the author's expertise? ??

  • Report this Comment On February 28, 2009, at 2:11 AM, nicko168 wrote:

    Based on the past weeks, the stock market has been a place for the guys to rally & show their frustration towards "Robin Hood".So, no matter what stocks u thinking of..forget it....

    Ultimately, do you know who's the real fools? Ha..Ha..

    Real fools are the one who plunge their own economy to zero together with the $787 billion stimulus plan. Why?

    They'll be slapping their own face caused it opens up the opportunities & competition to the "third" world to buy all the "CHEAP" US Companies..Arabi, China, Kuwait & maybe Iran, Iraq etc...

    Based on the recent news, US companies are selling off thier valuable assets (technologies, bank etc) in order to pull through the crisis & who are they selling to? Make a guess....AIG went to China, Singapore etc selling off their stakes..Another is selling their US technologies or commodities caused they're ridden by billions of dollars debt....At the end of the crisis, what will the US companies who once holds the supremacy in technologies, banking etc become? "Zero" is my answer...

    Who the losers? The real losers are the next generation facing the real US....

    There's a old chinese teaching:

    "To break one chopstick is easy..

    To break a bunch of chopstick, is difficult"

    To the real fools, WATCH OUT!!! Ha..Ha...

  • Report this Comment On February 28, 2009, at 12:30 PM, snowbuff wrote:

    One bank that often gets lumped in with BAC and C is Well Fargo in the mass media. All the MM can see is Big Bank with a big merger. Not always wise to lump them altogether. Beyond the glare that BAC and C are causing the MM sits blinded to WFCs substanial upside. Still rated as one of the safest banks in the world and the only bank in the US with the highest safety rating, long-term conservative top management, maybe the best distribution network now in the US, already paying the Govt back for money they didn't ask for, diversification of services, the bank of choice for those fleeing to quality which has resulted in a lost cost surge in deposits and the cash to set aside reserves for write-downs make it a real bargain for the long-term investor.

  • Report this Comment On February 28, 2009, at 12:42 PM, jasonjim wrote:

    The only way to recoup losses of the past 6 months or so is to take a chance on stocks which are very risky right now, but have the potential for massive upside gain over the next year as the recession slowly winds down. Such a stock is Bank of America (BAC), which at $3.95 has very low downside risk and very upside potential benefits. To win it is hard to go against the flow, but contrary to public opinion the meek do not inherit the earth. I don't care what toxic assets they may hold, BAC plus Countrywide plus Merrill Lynch just has to be worth more than $3.95 a share. Think about it! What was each entity worth before the recession came and the only words out of the media became 100% negative about everything.

  • Report this Comment On February 28, 2009, at 6:40 PM, brassbear wrote:

    I love how so many are denouncing Uncle Sam's various bail outs while so many big corporations are lining up to take the taxpayer's money. Such hypocrisy. If unregulated capitalism worked so wel, we would not be in this mess. Our government has a critical role to play in trying to get us out of the deep economic hole that wealthy, greedy executives in the private sector got us into. Some of the very conservatives crying foul about Obama's plans are the same ones whose financial masters are lining up to feed at the federal trough. I don't know whether or not which if any of the dministration's actions will help to dramatically improve our macro-and micro-economic situation but the private sector had its chance to control the outcome and blew it completely. Now its time to hope that the mix of government and private sector can maked the difference.

  • Report this Comment On March 01, 2009, at 5:03 PM, breathless9 wrote:

    Canadian banks are fine, but I like the fact that Ireland has only 2 major banks worth considering. Both have taken a big fall in

    pricing and the government insisted on pumping billions of euros into them to assure adequate capital for this recession.

    Some dilution of equity, of course. Still, both Bank of Ireland and Allied Bank of Ireland are the big fish in a little pond and warrant consideration. At less that 2$ a share. the gamble ain't that big. Hold on to the stock for your grandchildren, if need be.

  • Report this Comment On March 03, 2009, at 5:47 PM, lhowak wrote:

    Bank of America, Citigroup and AIG will survive and many people will kick themselves for not having the foresight to buy these stocks when they were super cheap. I predict that two years from now these financial giants will each be trading at around $10 a share.

  • Report this Comment On March 03, 2009, at 7:25 PM, cvbond wrote:

    By this articles logic, once can never ever invest in a bank. I assure you, the best wall street banking analyst (usually at goldman) cannot value a modestly complex derivative contract, if his/her life depended on it. Then how do we measure banks - just like human beings I presume. By their track record. Wells Fargo for instance took modest losses but got caught up in the general illiquidity of the assets and I suspect a lot of other well run banks too. chances are in 5 years it is a three bagger.

    Accountants and amateurs predict the future - for the rest of us mere mortals, it is risk/reward ratio with good money management

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