Big Banks or Small Banks

The Dow Jones Industrial Average delivered another spectacular performance yesterday – up 235 points to 8,504. Apparently, the recession is over, and most of the nation’s largest banks are as fit as a fiddle. At least that’s what we’re hearing from the folks who own banks stocks.

So why did we bother with that stupid TARP thing anyway? A lot of the banks now say that didn’t even want TARP funding. The government FORCED them take the money…and then forced the top executives to get by on less than $1 million per year. This whole situation has been so humiliating. Just imagine; being forced to take a $10 billion loan from the government, along with tens of billions of additional low-interest loans and special guarantees. And then imagine the agony of drawing a paltry $1 million paycheck from a company that would have gone bankrupt without the government’s help. It’s been a horrible, horrible experience for all involved.

Therefore, just a few minutes before the close of yesterday’s trading, Goldman Sachs, J.P. Morgan and Morgan Stanley announced that they would apply to re-pay the combined $45 billion of TARP funds that the government forced them to take last October. The incentive to repay this money is no mystery. After returning the TARP funds, these banks may return to their core business of generating plump investment returns for company executives.

“We don’t need this money,” these three large American finance companies insist. And it’s true; they don’t need THIS particular government money, as long as they can continue to receive other sources of subsidy, like the right to issue FDIC-insured debt and the right to borrow directly from the Federal Reserve at rock-bottom rates of interest.

Tell me, which other private enterprises in this vast land of ours enjoy such extraordinary privileges?

If the Goldman Sachses of the world wish to cut their executive- compensation-crimping umbilical to TARP lending, let them also sever every other umbilical to governmental coddling. Let them go it alone…truly alone… just like 99.9% of all other private enterprises in America.

But we’d guess that that’s not going to happen. The big banks will not go it alone. They will continue to nourish themselves at the teat of government-subsidized interest rates and lending programs. To do otherwise, would be to stray from the safety of the litter and to risk dying of exposure.

Out in nature, the infirm perish and the strong survive. But in the U.S. financial system of 2009, the infirm receive preferential treatment. The Government-Mother pushes aside her healthy offspring so that she can try to nourish her financial runts back to health. The annals of biological history do not feature a long list of species that thrived by nurturing their sickest members and abandoning their healthiest…and neither do the annals of capitalism.

Today, Goldman Sachs, J.P. Morgan and Morgan Stanley say they can do without TARP funds. So be it; let them do without TARP funds and without every other form of governmental assistance. And if they should encounter renewed difficulties six or twelve months from now, let them die…please. Spare us taxpayers the misery of rescuing Wall Street’s arrogant, unrepentant elite for a second time.

Our guess here at the Rude Awakening is that the big banks can do without TARP funds like a cistern can do without rain. For awhile, the pre-existing water will suffice. But eventually, this water runs out. If we were to make our metaphor even more accurate, we would note that this particular cistern has lots of holes in it. The balance sheets of the major banks still possess some very leaky assets.

Two weeks ago, at the Value Investing Congress in Pasadena, California, hedge fund manager Jason Stock explained why he remains skeptical the U.S. banking sector is on the road to recovery. By way of background, Stock and his partner specialize in BUYING bank stocks. They focus primarily on “small, under-followed bank stocks that the rest of the world just isn’t paying any attention to.” Stock made it very clear that he is much more interested in finding attractive bank stocks to buy than finding flawed bank stocks to sell short.

Stock and his partner are the kinds of guys who travel all over the country meeting with the managers of small banks. They are also the kinds of guy who corroborate the information they receive from the managers of small banks by conducting various boots-on-the-ground analyses. They drive around in the local communities, investigate the condition of the local real estate markets from a variety of angles, and interview real estate agents and trust officers.

“Unfortunately, in our travels,” said Stock, “based on everything we’re seeing, we still have a very bearish outlook. We think the US banking sector is significantly undercapitalized. We think credit quality is deteriorating and it will continue to deteriorate. We think the number of bank failures is still in the early stages and we see a fairly sharp increase [in failures] during 2009 and 2010. We think unemployment will continue to rise. And a big portion of our thesis is commercial real estate. We definitely see a significant amount of losses out on the horizon…”

We’ll be sharing more of Stock’s first-hand observations later this week, so stay tuned.

The Daily Reckoning