Wednesday, August 26, 2009

Time to Sell the Banks

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August 26, 2009  

Time to sell the banks…

I was golfing with Michael Masterson and his brother-in-law Sunday.

The conversation turned to the markets. Michael and I were surprised when he told us he had made back all his losses from last year. In fact, he said proudly, his portfolio was up 115% since March.

He was very excited. Desperate to make some money back, he got on the Internet and started reading everything he could about the markets.

He loaded up on bank stocks at their lows, and has seen his retirement account go to higher levels than ever before.

We both complimented him on his success. And then, simultaneously, we said, "Sell!"

Your retirement account is not something to gamble with. And while investing in banks early this year was a winning play, the inherent risks are growing, not shrinking.

The banking sector is an exciting market right now. With prices so low, it seems impossible that they won't eventually go back to where they were. But it's a sucker's bet.

Read on to find out why and learn how to make a very selective killing in the future.

Banks are failing at an alarming rate and they want your sympathy.

The New York Times wants you to believe that the bank failures are not because of highly-leveraged bets, toxic mortgages and a gamblers mentality.

"Banks are now losing money and going broke the old-fashioned way: They made loans that will never be repaid," says Floyd Norris, the author of the article.

"There were no CDOs, or SIVs or AAA-rated 'supersenior tranches' that turned out to have little value," he states.

Perhaps not. But the defaults that are happening now (and will probably increase sharply in the future) are still the result of highly-leveraged risk taking. The bulk of the defaults today were caused by a frenzied free-for-all. Insolvent buyers were being given all sorts of stated-income loans, no-income no-asset loans, and loans that would have never been made years before, when bankers were more responsible.

Banks have gotten used to taking money and gambling with it to boost their profits. There is little in the news today that indicates they have changed their ways. And even if they do, it will take a good, long time to clear out the trillions of bad mortgages that are still under cover in the system.

How a Starving Peasant Went From Living at the YMCA to a Net Worth of Over $8.2 Million Ted P. was $40K in debt. He had to get a loan so he could eat. Now, with a net worth of over $8 million, Ted has agreed to share the powerful secret that helped him amass a fortune.

For years banks were lulled into a sense of safety by low default rates.

To satisfy their irresponsible profit goals, banks lowered lending standards to boost their loan portfolio. They were abetted in this Ponzi scheme by real estate appraisers and economists who treated the hyper-inflation of property values as if they were real.

Warren Buffett famously said that when the tide goes out you see who was swimming naked. The tide is receding, my friend, and we haven't seen the entirety of the banks that were swimming naked. Analysts at the Royal Bank of Canada believe the U.S. still has banking failures "in the thousands" ahead.

Mortgage holders feel cheated now that they are holding loans that are greater than the value of their properties. But they were rushing to the banks for their loans then. They should have been paying attention to their common sense. Or they could have simply listened to our warnings.

Once your money goes to the bank, it's out of your hands. They can do with it what they wish. So when you borrow money – for a real estate investment or a business or for any other reason – you have to be sure that you will be able to pay it back.

In Automatic Wealth, Michael Masterson said that a smart investor never bets on assets whose maintenance costs are greater than their net worth.

Buying real estate only makes sense, he argued, when the rental income is sufficient to pay for all the expenses.

Investing in the later stages of the real estate bubble – when prices were so clearly overvalued – was a fool's game. Ask an investor who was doing it and he would tell you, "I'm not worried about that. I'll sell the property when the price goes up and make a fortune."

This is called the greater fool theory. "Yes, I'm an idiot for overpaying, but I'm sure there will be another idiot that will come along and pay an even more ridiculous price later on."

Playing that game is like passing a burning match from one person to another. But blindfolded. Somebody is going to get burned. And if you can't see the match when you take it, it's likely to be you.

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Speaking of banks increasing risk to chase higher returns…

Wall Street has not been chastened by the Great Recession. It is encouraging some banks to start taking bigger risks.

Following a recent Morgan Stanley conference call, two analysts suggested that the company needs to take on more risk.

After the bank reported a 3rd straight quarter of losses, Analyst Steve Delmacha and Amy Debone of FBR Capital Markets wrote, "Absent a more risk tolerant posture, we do not expect Morgan Stanley to sustainably achieve mid teen ROEs"

Translation: Unless they take on more risk, they won't make more money.

The writing is on the wall of these quarterly reports, my friend. Heed it.

Despite the bad service we've received, it's getting more expensive to be a bank customer lately.

Our Managing Editor Christian Hill learned the lesson recently. He let an old checking account linger. Eventually monthly fees drove the balance to a negative $2.15. This triggered $40 in fees from his bank, Wachovia.

"Instead of just closing the account when it went negative, they charged me $40 for having a delinquent account. Now I have to pay $42.15. to close an un-used account"

Christian's not the only one getting hit by increased fees. A recent Financial Times article reports that banks are going to collect over $50 billion in fees this year for customer over-drafts. This is almost double the amount collected in 2000.

You want a stimulus plan? How about keeping $50 billion in American's pockets to spend instead of the coffers of banks that got bailouts.

Banks are clearly trying to find any way they can to make more money. And it's not just the over-draft fees. All across the board the fees are increasing, from maintaining a checking account, to withdrawing money from another banks' ATMs. And it's only going to get worse.

Bernie Madoff has been smoking a pipe…

Another rumor is spreading about Bernie Madoff, America's most celebrated scam artist.

The rumor is that he has pancreatic cancer. If true, that means he will almost certainly be dead within a year. Pancreatic cancer is the most fatal of all cancers. More than ninety percent of its victims die within months of diagnosis.

And what was the reaction to this news at IDE's research table yesterday morning?

"It's proof that there is a Jewish god" says our value investing expert Andrew Gordon.

While the Bureau of Prisons states that the reports are false, Madoff seems to be worried about something. True or not, the story may have started when it was learned that Madoff joined a "Native American religious purification ceremony" that uses prayer, heated rocks, and smoking from a ceremonial pipe.

If he is dying, one has to wonder if he will finally come clean about the scam and tell us where all the hidden money is.

Good Investing,

Bob Irish
Investment Director
Investor's Daily Edge

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Market Window

Bob Irish - Investment Director
Andy Gordon - Editorial Contributor
Jon Herring - Editorial Director
Ted Peroulakis - Editorial Contributor
Christian Hill - Managing Editor
Dr. Russell McDougal - Editorial Contributor
Steve McDonald - Editorial Contributor
Michael Masterson - Consulting Editor


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