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Bank Statements

Quantitative Unease

First, do no harm. There should some version of the Hippocratic oath that would be administered to the Chairman of the Federal Reserve. Perhaps such an oath would have prevented the actions of last week—which were basically an admission by the Fed that it was out of bullets, except for some vague program to buy Treasuries with the proceeds of MBS run-off and sales. The market’s reaction was a predictable initial modest pop then followed by a shudder as it digested the reality that the American economy is now on its own, and that reality has not been made easier by Mr. Bernanke’s continued warnings that growth is slowing, recovery is uncertain, etc., etc.

Thank God, there is one Fed Governor who has not been brainwashed with Keynesian sludge—and he’s beginning to talk. The head of the Kansas City Fed, Thomas Hoenig, has continued his pattern of independent thought and speech by decrying the Fed’s present path and calling for a “slow and gradual” increase in the Fed funds rate as an antidote to the bubble economics practiced by the Fed since the days of Alan Greenspan. He has also pointed out the obvious—that job growth and other trends may be slow, but they’re also positive. Add to his pronouncements those of even left-leaning economists like Jeffrey Sachs—that the massive stimulus spending has been misdirected and mis-spent—and we’re beginning to see a push-back on conventional thinking and continued deficit ballooning that I hope will continue to gain momentum as the Fed’s influence recedes and the election nears.

In any case, the period between now and year-end will continue to be tough for bank stock investors, on both the long and the short side. So either be patient—or be out. While the Fed’s de facto quantitative easing will not aid the banks—it’s flattening the yield curve and taking away one of the few sources of revenue growth—the banks are still in exceptionally good shape to ride this out and see a change in both the economic and the political climates. Their focus needs to be in preserving capital and honing balance sheets in preparation for the promulgation of capital requirements by year-end, and we would not expect that there would be much said by any major bank managements (other than the usual discussions of credit quality improvements, liquidity, etc.) before then.

The one exception will be Bank of America (BAC-Buy, Target $19) where we would expect CEO Brian Moynihan to take advantage of the September conference season to begin to discuss his strategy for re-shaping the BAC franchise. While we have mixed feelings about this—we do not yet see a pressing need for Mr. Moynihan to begin a discussion of “big picture” issues while the “little picture” still is so uncertain—the Street is apparently clamoring for such a discussion. One thing seems certain—this CEO sees his mission as streamlining and simplifying a messy and unpredictable balance sheet, and that process will involve more selling than buying. The mission here is to get this company in shape to capitalize on a recovery when it comes and to be positioned for a rise in rates, at which time this company’s undervalued core deposit base will become incredibly valuable. We see BAC’s story as the industry’s most powerful in the coming year, and urge investors to accumulate accordingly.

Which goes to our main point—ignore what’s going on in Washington and focus on companies. Washington has already done just about all the damage it can do to the banking industry, and many of these companies are poised to flourish even as their antagonists flounder in November. The banking industry will, as usual, have the last laugh—and investors will be happy as well.