March 17th was a seminal day in U.S. financial services history. That was when the Federal Reserve, in an unprecedented move, guaranteed Bear Stearns’ assets and effectively placed a floor on the banking crisis.
Credit derivatives based on insuring bank defaults have rallied sharply since late March and indicate the worst is over for the U.S. and European banking system.
The Bernanke “put” is now in play. The Federal Reserve has effectively assured that no major U.S. bank or investment bank can collapse. Though the Fed concedes that it expects many smaller banks to go under as the economy continues to slow in 2008, larger institutions cannot fail.
The cost of insuring banks against default through the CDS markets, or Credit Default Swaps, has plunged recently as investors pay a lower premium to insure their portfolios from bank failure. The Bank of England’s latest policy initiative this week to essentially provide collateralized loans to member banks, similar to the Fed’s ongoing initiatives, has also acted to stabilize fears of financial Armageddon.
Insuring the senior debt of J.P. Morgan Chase, Citigroup and Merrill Lynch has plummeted 58%, 59% and 51%, respectively, since March. With the Fed literally guaranteeing the solvency of each of three behemoths, investors have started to bid some of the large cap bank stocks higher since last month.
But, like I said yesterday and previously in these pages, the long-term business model for the banks is uninspiring.
The securitization model will be totally revamped going forward – home to bulging profits for banks over the last decade. The loss of future revenues from synthetic derivatives means most banks will have to reinvent their staid business models. Plus, with regulators eventually introducing new laws and financial watchdogs surveying bank lending, it is hard to believe profits will be anything short of unimpressive going forward.
The Fed and the Bank of England have placed “puts” on the demise of the financial system. That is a good thing. The financial world we live in will continue to exist. However, banking and finance will never be the same as the wounds inflicted since last July severely crimp banks’ business models in the years ahead.
Banks will lead the upcoming stock market rally later in 2008 or in 2009; beyond that short-lived spurt, I expect banks and most global indices to post dull returns over the next several years. With banks representing about one-third of total global stock market capitalization, investors will have to look beyond simple global indexing and wager concentrated bets on countries, sectors and asset classes.
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