Commentary

Banks Bounce Back from the Dead

Bank shares are back in style. Even after staggering losses were announced by the likes of Wachovia, which registered a $8.9 billion loss in the second quarter, and Washington Mutual, which posted a $3.3 billion stain of red ink in the same period, their shares traded up by 27 percent and 6 percent, respectively.

The share prices of other banking industry invalids also rose smartly on crappy results – Fifth Third Bank, KeyCorp and SunTrust all witnessed miraculous increases in their market values since late last week after reporting major losses during the past quarter.

What do all of these banks have in common? They are all suffering the dire consequences of souring real estate loans. Washington Mutual admitted that a record number of customers were falling behind on their mortgage payments. And Wachovia is experiencing a scary rise in defaults on its big basket of pay-option mortgages, which are among the most reckless loan products created during the giddy years of the now late real estate bubble.

The real problem for banks is that the bad loan contagion is spreading well beyond dubious subprime mortgages. As the economy slows (due in large part to the downward tug on home prices and the subsequent drag on spending), consumers and businesses alike struggle to service more conventional types of loans. Once happy consumers are rapidly falling behind on auto and credit card loans, and big banks are beginning to write off larger numbers of small business loans.

After the stomach-turning sell-off in financial shares that started early this summer, the sector was due for a bounce. But, believing that the worst is over just because the earnings news was not biblically bad, many investors are waving the “all-clear” signs too soon by bidding up bank share prices.

As the bursting of the housing bubble and the resulting credit crunch ripples through the economy, more consumers and businesses will be caught in the undertow. This means that more conventional loans will continue their descent into the non-performing category. As for banks, business will get worse in the months ahead. If you’re an investor interested in plucking some cheap banking shares, please, tread carefully.

I’d love to know what you think, too. Leave a comment in the section below, and/or While you’re here, sign up for my feed and join the conversation!

© 2008 Splendid Marbles.