Case-Shiller Home Price Index

Problems. Problems. Problems.

I have mine….You have yours. He has his….. She has hers. The world is full of them.

But some problems are much bigger than others. And when they break the wrong way, even innocent bystanders get taken down by them.

Now here’s a big problem for you: The banks gave a ton of money out to people that couldn’t possibly pay it back. Not real smart if you ask me.

And of course, when the people they gave all that money to met their dates with reality, the problems really started. The Case Shiller Home Price Index began to tumble and so did the banks.

So today, tomorrow and the next day, falling home prices are everybody’s problem now because the banks that made those not so smart loans are insolvent. In short, they don’t have enough cash on hand to cover their losses. And with falling prices, those losses are a bottomless pit.

And if nobody is willing to lend these not so brilliant bankers any more money to mop up it all up they end up in place that is the equivalent of banker’s hell—in default themselves.

Now picture that for a moment…banks begging for loans. Welcome to what my pal Chris Nelder calls Upside-Down-World.

And if there is one thing you need to avoid in upside-down-world it is banks, which are no better than sub-prime lenders themselves. However, the problem is that it is still almost impossible to tell the bad ones from the really, really, bad.

So I’ll say it again: buying financial stocks is not for the average retail investor-the risks are too great. Your investment could go to near zero in the blink of an eye.

That’s what happens when the FDIC shows up at your door and shuts you down. Or when you can’t pull off your latest round of capital raising. The rumors suddenly become reality—sort of like the dot com crash, but with banks.

Now that, to me, really is a problem. E-Toys we can live without. Impaired banks, however, are nightmare.

After all, credit is our air hose.

Problem Banks Bury Financial Stocks

As for the number of "problem" banks, the list is getting longer every day. The FDIC said on Tuesday 117 banks and thrifts were considered to be problems in the second quarter. That was a 23% jump from just 3 months ago when the figure stood at "only" 90.

But the truth is the number is probably much larger. Indy Mac wasn’t even on the list when it failed in June. That problem alone may cost the FDIC over $8.9 billion to fix, well above the original estimates of $4 billion.

The FDIC statement also revealed federally-insured banks and savings institutions earned $5 billion in the April-June period, down from $36.8 billion a year earlier. That’s an 86% haircut for institutions that can hardly afford it.

Troubled assets — loans that are 90 or more days past due — also continued to rise, jumping by $26.7 billion, or 19.6 percent, over the first quarter. It was the first time since 1993 that the percentage of total loans that were troubled broke 2 percent, at 2.04 percent. That number is lkely headed higher.

Meanwhile, the FDIC is already planning to borrow as much as it needs from the U.S. Treasury to see through the crisis. Its $45.2 billion fund won’t even come close to covering the eventual losses.

Of course, the last time the FDIC borrowed funds from the Treasury was during the S&L crisis of the early 1990s. But here’s the kicker. That was at the end of the crisis after thousands of banks failed, not the beginning. To date, just nine banks have failed this year. According to banking analysts, as many as 300 banks could fail this go round.

But there’s more.

The big banks are in deep trouble too this time, not just the smaller ones.

Kenneth Rogoff, a leading academic and former IMF chief economist warned, last week, "We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one – one of the big investment banks or big banks."

So somewhere out there beneath the waves there is whale or two. Its business model is wrecked and it is loaded down with more debt than it can swallow. However, one thing is for sure, when one of these whales washes up on the beach it going to take financial stocks down another peg with it.

The Case Shiller Home Price Index: More Pain

In the meantime, the housing mess that started it all is still in an absolute free fall. That’s important because the bottom of the banking crisis is nowhere in sight until home prices stabilize. That’s just not happening as housing begins another leg down.

Through June 2008 the S&P/Case-Shiller home price index posted its biggest yearly decline falling 15.9% nationwide year over year. But to put that into perspective you have to take a look at the chart. It gives ugly a new meaning.

Now if that’s not a crash, I don’t know what one is. In truth, it’s the 500 lb. anchor that is dragging financial stocks to their watery graves.

So it’s simple. The banks can’t bottom until housing does. That won’t be until 2010 at the earliest—even then it would be miracle in the midst of a credit contraction.

In other words, the worst is yet to come. So don’t make their problems your problems if you don’t have to.

After all, who needs more problems? Not me.

In fact, I would sooner drink bleach.

Then again there is always the UltraShort Financials ProShares (AMEX:SKF). It goes up when banks go down.

Your avoiding-problems analyst,

Steve Christ

Investment Director, The Wealth Advisory

PS. Bad banks may be off my list, but there are plenty of other sectors to invest in these days. In fact, since the first of the year The Wealth Advisory is 11-5 in its closed positions with a cumulative gain of 290% vs. losses of only 55%. That is a net gain of 235%.Bear what?

To learn more about The Wealth Advisory click here.