Take yourself back to March 2009. It was the peak of the financial crisis. Nearly 800,000 jobs were vanishing every month, GDP was falling at a rate not seen since the Great Depression, and home values were in sheer free fall. The question wasn't if, but who, was the next Lehman Brothers. Many, including myself, thought the government should be proactive and put the weakest banks out of their misery. "The Treasury secretary seems stuck on keeping the banks we have in place. But we don't need zombie banks overstuffed with nonperforming loans -- ask the Japanese," wrote investor Andy Kessler in The Wall Street Journal. "Six months to a year from now, big banks may still be weak and the ugly 'n' word of nationalization will be back."
Policymakers took the idea seriously. According to recent reports, President Barack Obama asked Treasury Secretary Tim Geithner to draw up plans to nationalize Citigroup (NYSE: C) in early 2009. This hardly would have been a surprise to the market. Then just a penny stock, it was the outcome many expected.
Confidence was nowhere to be seen. March 2009 was about as pessimistic as it could get in the banking sector.
And you know what's amazing? The mood is almost as gloomy today.
The entire market has sold off over the past few months, but no sector has been hit as hard as banks. The three largest, Citigroup, Bank of America (NYSE: BAC), and JPMorgan Chase (NYSE: JPM), now trade below book value -- in B of A's case, a 70% discount to book value. Wells Fargo (NYSE: WFC) trades at 1.1 times book value, about a third of where it did a few years ago. The plunge these banks have undergone is striking:
Source: S&P Capital IQ.
Even looking at tangible book value, which ignores the value of goodwill, B of A and Citi trade at nearly half of par -- discounts not seen since early 2009. It's just as bad for investment banks Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS). Both now trade at share prices and price-to-book multiples close to March 2009 levels.
It is as if everything good that's happened to banks since 2009 -- the recapitalizations, the deleveraging, the working off of bad assets, the retention of earnings, the tightening of credit standards -- has suddenly either been forgotten, or written off. There isn't panic, but a noticeable shock and awe is moving through the banking sector.
What should you make of it? Some, predictably, smell opportunity. Barron's cover story this week is titled "Buy the Banks," and states clearly:
The financial industry is in far better shape than the stocks in the sector would lead you to believe. ... The stocks -- major banks, regional banks and trust banks, as well as life insurers -- look appealing, with many trading at or below tangible book value, a conservative measure of shareholder equity, and at single-digit price/earnings multiples. The stocks are even cheaper based on stated book value, which includes goodwill from acquisitions. Most stocks now discount permanently low returns -- an overly bearish scenario -- just as they reflected permanently high returns not so long ago. Dividends are often in the 2% to 3% range -- and probably heading higher.
It may be onto something. Always comforting, Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) bought shares of Wells Fargo last quarter at prices likely higher than you can fetch today. The last time banks traded at these valuations back in 2009, the ensuing returns were hellacious, in a few cases returning several hundred percent in a matter of months. A few investors, including hedge fund managers David Tepper and John Paulson, made dynastic fortunes in 2009 buying bank stocks at prices similar to today's. Buy when there's blood in the streets, we're told -- and there's plenty of blood today.
But not so fast, others say. The situation in Europe could turn into an unmitigated disaster just as Lehman did three years ago. Here in the U.S., loan demand is tepid at best. With the Federal Reserve recently announcing a plan dubbed "Operation Twist" to lower long-term interest rates, net-interest margins are bound to fall, putting even more pressure on bank profits -- assuming there were any profits to begin with. And don't forget derivatives. That's still a multitrillion-dollar market that few, if anyone, truly understand. If banks need to raise capital by issuing new shares, price-to-book multiples could soar, making what look like bargains today a sucker's bet tomorrow.
And here's the kicker: What saved banks in 2008 and 2009 were, of course, the bailouts. Should banks get into trouble yet again, that net can't be counted on. Last month, Moody's downgraded Bank of America's, Wells Fargo's, and Citigroup's debt because the government is "more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled," it wrote. This is an extension of last year's Dodd-Frank financial reform bill, which created rules to guide banks gracefully into the grave should they face insolvency, rather than a Sophie's choice of sudden collapse or bailout. In that sense, there may be more risk in the banking sector today than in 2009, at least from shareholders' points of view.
Like all investments, it boils down to risk vs. reward. Bank stocks could bring large, quick returns. They could also bring violent, sustained losses. Are you willing to play that game? After 2008, many aren't. Once bitten, twice shy.
