Is it Safe to Buy Financial Stocks Yet?

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Financial stocks have been downright pounded in recent months, as their holdings have been considerably devalued with foreclosure numbers growing higher and higher by the day. The financial sector as a whole (using XLF as the base) has dipped more than 75% since its peak in May of 2007. With what looks to be a bottom in sight, the financial industry could very well lead the rebound out of the global recession.

The Government Knows No Limits

In total, the US government has pledged or already allocated nearly $9 trillion to the banking sector in a variety of methods. According to Bloomberg, the total amount dispersed and promised by the government is currently equal to 90% of the mortgage market in the United States. This comes after news that the government would lend an additional $3 trillion to fix the credit crunch, with $800 billion coming from the economic stimulus package and the remainder from a combined effort from the Treasury and Federal Reserve, with some hope that private equity would also be used to fund future bailouts.

Understanding How the Bailouts Worked

Many banks received loans, while others enjoyed capital infusions, and still others received a full bailout. The fully bailed out banks are those that received not only capital infusions, but also asset backing from the Fed, where the majority of the write-downs would be covered by the Federal Reserve with banks kicking in just 10%. In one case, Bank of America received a capital infusion and bailout that would give the bank $20 billion, with a backing of more than $110 billion worth of loans against losses. In this case, Bank of America would have to write down the initial $10 billion with the remaining losses to be split 90-10 between the Federal Reserve and Bank of America. In return, the American taxpayer received a hefty stake of 6% of the banks outstanding shares through various bailout initiatives.

Inflation Can Solve the Banking Crisis

It appears now that the goal of both stimulus and bailouts is to inflate the money supply to a point higher than when the recession began. This way, the rise on the money supply can help re-inflate home prices, as well as costs for everything else, to make homes seem less expensive. The idea is, of course, that inflation will bring up the price of everything, including wages and the number of people employed, to expand the real estate buying market. More people with more money means more people buying real estate, and the great funds that banks have, the better chance that future buyers will be able to get credit and at a favorable interest rate. This view is derived from the fact that only $50 billion of the economic stimulus package will be put towards ending foreclosures, while trillions of dollars have been pumped into the banking sector to do the exact same thing.

The More that Fail, the Better for the Others

Obviously, any business owner likes to beat out their competition, but in the case of the banking industry, this has to do with monetary policy more than anything else. If one bank were to write down billions of dollars of loans at the Federal Reserve’s expense, this money would have to be monetized via inflation. As stated above, inflation can help turn around real estate prices and all other goods, and ultimately, give a short boost to the banking sector. At this point, the banking industry as a whole can only benefit from the monetization of losses from the Federal Reserve at the expense of dollar holders in the US and abroad.

Is it Time?

With virtually a blank check from the US government and the Federal Reserve, it certainly appears that the time is right to begin bottom-picking banking stocks. Banking stocks are dirt cheap, and many quality names have been hit by the selloff, but not yet by the crisis. For the long term player, the argument can be made that dollar cost averaging at these levels seems appropriate.

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