This has been called the worst financial disaster in 80 years. The market seems to agree, with the S&P 500 dropping more in percentage terms than any time since the Great Depression.
Yet, not all companies are going to suffer from this crisis. Some businesses will, in fact, have improved long-term performance as a result of this disaster. These businesses will be more profitable, with greater market share, and stronger growth.
What's more, many of the companies in this situation are financials, some of the very firms that helped cause this catastrophe.
Profiting from negligence
Yes, you read that right. Some of the companies that helped cause this crisis could benefit from it, starting with some of the investment banks that bundled toxic mortgages into mortgage-backed securities to sell to investment funds.
Back in 2007, there were five big investment banks. Two of them were Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), who packaged securitizations but were smart enough to realize that they were selling radioactive sludge, and avoided a lot of the troubles. Their three competitors were not so astute. As a result, Lehman Brothers has gone under, and Merrill Lynch and Bear Stearns were acquired.
So, a market that used to have five huge competitors now has two. Over the short term, Goldman Sachs and Morgan Stanley have both been hurt. But over the long term, it's much better for these investment banks to be the only big players in town. As a duopoly, they'll gain pricing power and market share in many aspects of their business. Sure, Merrill and Bear might not be completely out of the game, but it seems likely that, now that retail banks own them, they won't be in the same league.
Big bank bonanza
The surviving retail banks could be in a similar position. A few of the big money center banks, such as JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC), recognized that short-term profits were less important than survival, so they were conservative in their lending practices. As a result, these companies were in the position to acquire Bear Stearns, Washington Mutual, and Wachovia -- banks that chose more reckless paths.
Now, not only have JPMorgan and Wells Fargo acquired assets and retail banking locations when they were priced for an apocalypse, but us taxpayers have generously helped pay for the acquisitions. We did this directly, as with the $29 billion non-recourse loan that the Fed provided to help JPMorgan acquire Bear Stearns, and indirectly, by providing TARP capital. JPMorgan's CEO, Jamie Dimon, himself commented that TARP would help JPMorgan be "a little bit more active on the acquisition side or opportunistic side for some banks that are still struggling."
So, with taxpayer help, banks are buying assets at fire sale prices, thereby both reducing competition and picking up market share. What's more, it's happening at the right time. Mortgage rates spreads -- the difference between the rate at which the banks borrow money and the rate at which they lend it -- are at levels not seen since the early 1980s. The reduced competition and cheaply acquired assets will likely enable these money center banks to come out ahead in the long term.
That said, both the retail and investment banks are still risky investments. Both JPMorgan and Wells Fargo have bought assets in a fire sale. Many acquisitions don't work out, particularly in the financials, where leverage is high and assets are tricky to value. What's more, all banks are likely to face increased regulation, which could hurt their businesses. Nevertheless, the odds look attractive.
Red tape is a buy
While regulation will hurt the banks, increased regulation could actually help some companies. Credit default swaps (CDS) -- insurance on bonds and securitized debt -- basically destroyed AIG. But, there's nothing inherently bad about credit default swaps. Rather, the problem was that CDSs were largely unregulated -- AIG was able to sell billions of dollars of swaps without having the collateral to pay when the problems arose.
Our regulators are nothing if not reactive. Only years after the CDS market became big enough to threaten the country's financial system, and months after the world's largest insurer needed a $170 billion bailout, the regulators are on the case. They recognized that CDSs should be traded through a central clearinghouse, like stocks and options, instead of market participants trading directly with each other. This would reduce counterparty risk -- the risk that the seller of the credit default swap fails to pay. Plus, it would increase market transparency and make it easier for market participants to manage risk.
CME Group (NYSE:CME), NYSE Euronext (NYSE:NYX), and IntercontinentalExchange (NYSE:ICE) have all received approval to operate clearinghouses. This market has the potential to be huge -- right now, there are about $45.5 trillion in credit default swaps outstanding at face value. Though the fair value of these swaps is substantially less, the market nevertheless has the potential to be huge. CME, NYSE, and Intercontinental will reap the benefits of functioning as clearinghouses for this massive new market.
The Foolish bottom line
Some of the outcomes here aren't remotely fair. But investing isn't about fairness. It's about making money, and there is an opportunity here. Not only are these companies facing reduced competition while opening new markets and increasing market share, but as a result of the financial chaos, investors have the opportunity to pick up these stocks at rock-bottom prices. Historically, that combination has been a recipe for wealth.
Of course, if you'd rather avoid the volatile financials, companies in other sectors have benefited from this crisis as well. Many of them are also trading substantially below their fair value. Our Inside Value team has found several stocks like this that we consider extremely compelling right now. You can read about all of them with a free trial. There's no obligation to subscribe.
Fool contributor Richard Gibbons looks more and more like a farm accident every day. He owns LEAP calls on Wells Fargo and shares of CME Group, but no position in any of the other companies discussed in this article. NYSE Euronext is a Motley Fool Rule Breakers selection. The Fool's disclosure policy is printed on 98% recycled pixels.
