Bank Investors Beware, Shareholder Interests Are Secondary

Includes: BAC, IYF, MER, PGF, XLF
by: Alan Brochstein, CFA

As the financial system continues to crash under the weight of falling asset values and shrinking availability of capital outside of government investments and guarantees, it is rapidly becoming clear that the emperor has no clothes. When the rumors hit the tape on Wednesday night that Bank of America (NYSE:BAC) had been secretly negotiating with the government since mid-December to keep its Merrill Lynch (MER) deal alive, the failure of the stock to bounce and its subsequent weakness from early January became quite explicable.

What's not as easily understood is why shareholders didn't learn of this (they had voted, but the deal hadn't closed), unless one understands that the interests of the shareholders in large banks are subordinate to the "national interest". According to a NY Times report, CEO Ken Lewis stated during the conference call yesterday (no transcript on Seeking Alpha yet): “I do think we were doing the right thing for the country.” We heard similar type of discussion when Treasury Secretary Paulson "forced" TARP funds on some banks as well as in some of the previous shotgun merger discussions.

The Philadelphia Stock Exchange Banking Index (BKX) has already declined 29% in just 11 trading days of 2009 (after falling in each of the prior three months a combined 35%). Investors in banks and other companies on the receiving end of government assistance need to be aware that these companies don't necessarily have the interests of the equity investor at the top of their list of priorities.

Investors in general need to understand how this deference to the "greater good" indicates the true magnitude of this crisis. While stocks have actually rebounded somewhat since this revelation, I believe that options expiration, rotation into other sectors and some expectation of a potential post-inauguration bounce are at play.

The conclusion I draw is that the need for secrecy of the negotations, the abrogation of shareholder rights, the massive "investment" required by the government and yet still vast damage to the stock price suggest that investors don't like to invest when the game is rigged.

Disclosure: None