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May 2, 2011, 12:01 a.m. EDT
By Shah Gilani
NEW YORK (MarketWatch) "” Everybody loves a bargain. And, as equities bump up against multi-year highs, lagging bank stocks look downright cheap. But, don't be fooled. They're cheap for a reason.
In fact, there may be hundreds of billions of reasons that bank stocks are cheap.
Banks face regulatory uncertainties from still unwritten Dodd-Frank rules. They'll face serious challenges from the just getting ramped-up Bureau of Consumer Financial Protection (CFPB). And, they have to deal with tougher capital reserve requirements and risk constraints under new Basel III international standards.
But, the biggest reason banks are cheap is because they could end up facing potential litigation losses that could cause even some of the biggest too-big-to-fail banks to fail.
I'm not talking about the foreclosure scandal with its admitted robo-signers, falsely filed legal documents, corrupted chain-of-title issuance, and the rest of the dirty laundry that accompanies the sordid details of banks running amok. Sure, there will be millions, more likely billions of dollars of legal costs, fines, foreclosure fixes, and class-action suits. But, that's small potatoes.
I'm not talking about the potential hundreds of billions of dollars of mortgage "put-backs" banks face as investors, including Fannie Mae and Freddy Mac, shove defaulted mortgages back onto bank balance sheets because they "improperly" packaged them into healthy-looking securities. That's small potatoes.
I'm not even talking about the potential criminal and civil fines banks face if they are found guilty of fraud and collusion (and dare I say, possibly racketeering) for which they are being investigated now.
I am talking about potential litigation losses in class-action suits based on the findings of these investigations that could easily reach hundreds upon hundreds of billions of dollars.
Several big banks are already individually negotiating with the SEC according to a recent Wall Street Journal article on paying untold fines to settle fraud charges without admitting or denying guilt that they defrauded investors by aggressively selling them shoddy mortgage-backed securities. See banks near deal with SEC
That cat isn't out of the bag yet, so we don't know what the exact "alleged" charges are that banks are negotiating to wriggle out of for a cash settlement.
But one thing is for sure according to what noted New York securities attorney Bill Singer was quoted saying in a recent Forbes article on the subject, "Where there are banks, there is money "” lots of money; and if there is even a whiff of criminal prosecution that will likely spur many class action law firms to come out of the woodwork."
Singer wasn't talking about the SEC investigation. He was actually talking about the U.S. Department of Justice's antitrust and antifraud divisions investigating banks for among other things, collusion to manipulate the most important interest rate in the world, Libor.
Hundreds of trillions of dollars of loans and derivatives are priced based on Libor.
Imagine global banks being found guilty of antitrust violations for conspiring to artificially lower Libor rates and masking, not only their own weakness, but the weakness of the financial systems that came crashing down in the credit crisis and caused the Great Recession.
In the U.S. treble damages can be awarded in antitrust cases. The potential losses banks face are, literally, incalculable.
And, to add insult to injury, Senator Carl Levin who just released his U.S. Senate Permanent Subcommittee on Investigations' 635 page report titled "Wall Street And The Financial Crisis: Anatomy of a Financial Collapse" promised to have the Justice Department take follow-up action on that report's damaging revelations.
So, maybe the banks are cheap. And maybe if you're a bottom-fisher this might be a good time to throw a hook into the muddy water.
But for me, the fact that Goldman Sachs /quotes/comstock/13*!gs/quotes/nls/gs GS +0.62% is 20% off its recent high, Morgan Stanley /quotes/comstock/13*!ms MS +0.19% is 24% off, Bank of America /quotes/comstock/13*!bac BAC +0.86% is 32% off its high over the past two-years, and the rest of the big banks are floundering and going nowhere while stocks, in general, are making new highs, says enough.
I like a bargain. But cheap usually means something else. And with banks facing litigation costs and potentially incalculable losses, I'll do my fishing elsewhere thanks.
Shah Gilani is the editor of The Capital Wave Forecast.
Shah Gilani is the editor of The Capital Wave Forecast.
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