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Our Game Plan for Financial Stocks

Written By Brian Hicks

Posted August 30, 2010

Buy financials for the near term.

This is an election year. That means we’re likely to see two things happen before November 2010… 

We’re likely to see quantitative easing — again — which will goose the market as it did in March 2009.

We’re also likely to see the White House step in — again — and goose the battered housing market before housing realities set in again.   

We can’t keep throwing money at the problem… and hope that it works out

But so long as the White House kicks the can down the road, here’s some immediate-term good news for housing and financials.

Some time this week, according to the Housing and Urban Development Secretary Shaun Donovan, the Obama Administration could unleash two new initiatives to help the crumbling market:

“We’re going to be rolling out an FHA refinancing effort to help borrowers who are under water in their homes get above water,” Donovan said.  “And second, we’re launching an emergency homeowners’ loan program for unemployed borrowers to be able to stay in their homes.”

(Because past programs have worked so well?)

Unfortunately, leaving the housing market alone and letting it crumble as it will anyway isn’t an option…

The door is now also open to reviving the $8,000 tax credit for first time homebuyers. This will only temporarily fix the problem. And as we saw with the last expiring credit, housing will resume its slide on credit expiration.

Short financial stocks… once the “hype” wears off

We — along with Meredith Whitney — don’t believe major banks are prepared for what’s coming.

They’ll need more capital as housing worsens. They could be nothing more than sitting ducks without it, once Option ARMs reset, foreclosures mount, and people are forced to walk away from their homes.

The banks know that 14 million homes are underwater… that 2.3 million homes have less than 5% equity… that two million homes sit empty with “for sale” signs… and that another seven to eight million homes are falling into delinquency.

The banks are also aware of the fact that strategic defaults are likely to strike, as refinancing a home has become nearly impossible.

By the end of 2011, according to Deutsche Bank, we’ll see another six to 20 million homes under water — easily sparking strategic defaults (especially in states with no bank recourse action).

The White House can try and help all they want, but the only permanent fix is to allow housing to collapse.

The banks are still ill prepared for it all         

You’d think the banks would have wised up, having come close to collapse under the strain of surging loan defaults and collapsing property values in 2008…

When the economy was tumbling into recession at the tail end of 2007 on mounting subprime defaults, banks reported more than a trillion dollars in losses and cut thousands of jobs.

You’d think they’d remember that it was an exhausted taxpayer — err, government intervention and efforts to raise additional capital — that saved them the last time.

But nothing, it seems, has changed.

The banks may need more assistance going forward, as housing is likely to weaken further.

Record low sales, talk of double dips in housing, and growing foreclosures on top of promised government assistance that hasn’t materialized just make it worse. 

And many homeowners have been left to fend for themselves with complicated, ever-changing programs that do nothing but prop up the industry.

So is it really a shock to hear that people are strategically defaulting — or walking away?

Not at all…

In fact according to JP Morgan Securities, if housing prices remain flat, 13 million borrowers are likely to walk away from their mortgage.

These borrowers will add to the glut of unsold homes and hurting banks; the banks would lose money on the investments and stop lending at a quick pace.

When all is said and done — and the government decides to stop kicking the can down the road — the banks still won’t be ready for what’s coming: foreclosures, defaults, even Option ARM resets…

Buy the hype near term. Short the hype long term.

Stay Ahead of the Curve,

Ian L. Cooper
Wealth Daily