Banking Sector: 'Buy When There's Blood in the Streets'?

Three major U.S. banks - including Fifth Third Bancorp. (FITB) and Wachovia Corp. (WB) - got clobbered in recent days on the news that they’ve lost another $1.6 billion by making investments in the Citigroup Inc. (C) Falcon hedge fund that lost 75% of its value earlier this year.

It’s just the latest chapter in a continuing credit-crisis saga that’s gone on for so long that many investors have become numb to the news: They regard all new developments with a kind of "so what" attitude, or just ignore the news completely.

Believe me when I say that such a response is easy to understand. But hear me out as I underscore why investors must continue to watch this financial-services-sector saga closely. It’ll keep you out of trouble.

Let me explain …

The funds were invested the premiums from so-called "Bank Owned Life Insurance Vehicles," or BOLIs, which are designed to pay off when key employees die.

BOLIs, in case you are not familiar with them, are specialized policies typically purchased as an employee benefit. Banks use them to fund such expected costs as employee compensation and the accompanying benefits. Like most life-insurance-type policies, BOLI policies contain both an investment feature and a death benefit.

And that’s why banks like them.

Not only does the bank accrue investment earnings revenue because they own the policies (bank-owned is the "BO" component of "BOLI"), the financial institution also receives the death benefit.

And since neither the death benefit nor the increase in the value of the investment vehicle is taxed, BOLIs became the mother of all tax shelters for banks.

And that brings us to the core problem.

You see, by taking the investment portion of the life insurance policies and moving them from traditional portfolio choices into more risky hedge funds, a bank, or in some cases the insurance company that sold the bank the BOLI policy, could increase its investment return with an almost-instantaneous, performance-enhancing boost that looked good to regulators and shareholders alike.

Of course, if you’re a baseball fan - as well as an investor - you know very well that there’s a downside to "performance-enhancing" boosts, even though the dramatic performance gains make that dark side very tough to resist.

That’s clearly why Fifth Third, Wachovia and a still-unnamed regional bank risked a reported $1.6 billion of their respective BOLI programs, an anonymous source close to the matter told MarketWatch.com. Many banks, presumably including these three, use BOLIs to offset the costs of their employee benefit programs.

And they’re not the only ones….

BOLIs have proven to be so popular that banks - always looking for additional ways to "rev up returns," according to one news report - had more than $120 billion invested in them as of the end of last year.

But now the chickens are coming home to roost.

Fifth Third is suing Transamerica Life Insurance Co. - which sold it the policies - on the grounds that these investments in the Falcon fund were much more risky than the bank allegedly thought. Fifth Third also named Clark Consulting Corp. as a party in the lawsuit. Both Transamerica and Clark are subsidiaries of the Netherlands-based Aegon NV (AEG).

"As with many other credit-based investment products, the Falcon’s returns have been hurt by one of the most volatile periods for fixed income in recent memory,” said Citigroup spokeswoman Danielle Romero-Apsilos, Bloomberg News reported.

Filing a lawsuit is the Corporate America’s version of a high-school kid telling his teacher "the dog ate my homework."

It seems to me that if you weren’t so greedy in the first place - and had simply stuck to your knitting with prudent, risk-averse choices that didn’t require all this creative accounting - you wouldn’t have had a care in the world when Citi’s Falcon Fund lost three-quarters of its value.

The bottom line: There could be an entirely new wave of write-downs encroaching onto financial-services firms’ corporate earnings reports in the next few quarters to come. And, as was the case with the initial part of the subprime-mortgage debacle, some investors are likely to be very surprised at the identities of the early casualties.

But other investors will continue to say "so what?"

Investors who continue to follow these developments will do so with the understanding that this, too, shall pass - and some pretty profit plays will ultimately start to show themselves.

We’ll be there to tell you when that happens.

And it’s likely to begin well before you’d expect it.

After all, as the old Wall Street adage says: "Buy when there’s blood in the streets."

And if you’ve been paying attention, you’ll be able to say with confidence that none of that blood is yours.

Comments

[User 68127:]

Good explanation of BOLIs. As for your "trust us and we'll tell you when to buy" assurance--where's the beef? Why should we trust you?

2008 May 29 01:27 PM

[SW Richmond:]

the old Wall Street adage says: "Buy when there’s blood in the streets."

This adage is only true as long as the Fed is relevant. This is the same thing as saying "don't take the opposite side of a trade from the Fed". This clearly reveals the paradigm of investing in the 80's and beyond: "The stock market always goes up. You have a right to expect the stock market to always go up, except when it corrects briefly, only to resume going up again." An entire generation has been raised on this paradigm.

When we left convertibility in the 70's, the only way to keep the party going was constant monetary inflation. Constant monetary inflation makes everyone a stock market genius: you just put money in, and it gets bigger! What a concept! There are plenty of cocky 30- and 40-something bright boys driving around in Hummers that believe in their own legend. And they can't stop believing. It's just not possible for them.

We have inflated our way to a $9 Trillion debt, and a $50+ Trillion unfunded liability, and all the elder bright boys say it's no big deal, because there is no end to easy money.

Or is there? Has the world had enough of Americans consuming (by borrowing) the collective savings of the rest of the world? Does the rest of the world see that the only way out of our debt trap is by more inflation? Greenspan always said "We can guarantee Americans benefit payments but not purchasing power". That's pretty obvious, isn't it? Where the hell are we going to get $60 Trillion dollars? Bernanke said: "The logic of the printing press must assert itself". I'll take his word for it. Is the commodity spike nothing more than savers fleeing paper assets? That's what it is for me.

Blood in the streets is a buy signal only if the Fed can reinflate. You bet your ass. Literally.

2008 May 29 10:40 PM

[OJO Zafado:]

SW Rich has defined the new paradigm. Slowly I turned inch by inch step by step, We have not yet seen two consecutive negative TIC reports in the last year or so. It seems that Ben the Dollar slayer was being too cute with his remarks on linen fiat currency. Recently we have seen hundreds of billions of "dollars" created by the Fed electronically. $75 billion here for some TFAs a couple hundred billion there for some TRCAs to the ECB, SNB, & BOE. Hey no problem Ben has saved the taxpayers money by not printing the linen, but instead creating it with a few key strokes to the computer and a "press SEND". Electronic money! We are the ones who flooded the world with dollars to fill the shelves of Walmart and supply the refineries of Exxon-Mobil. "They" are just not playing fair converting those dollars to assets with intrinsic value after we also slimed "them" with subprime CDOs, SIVs and other junk debt. UBS is a Swiss or German bank. They are the ones leading the pack admitting to over $40 billion in write downs ..so far. It is not a US Bank that is losing the most. The Chinese have gotten crushed in US treasuries even as rates hit new lows. Now they spend more US linen on stocking their Strategic petroleum reserve than buying new US treasuries. It became a perfect storm when the advent of the ETF allowed any John P Public with $500 to open a Scottrade acct, to own GLD, SLV, USO,UHN, KOL,UNG, DBA,MOO etc, You name it if it has intrinsic value you can now own some of it in lieu of the US$. We are seeing the slowly I turned stealth run on the dollar. Now rates are moving quiclkly higher and there are some other major slobs, probably some CD holders getting the short end of the trade in PST & DXKSX. There are just not enough chairs when the music stops. I may still end up drawn like a moth to the flame buying some WB if it trades below $23. It will be an interesting Summer market. Either a stronger move higher based on some vague "Change" enthusiasm or the typical Summer doldrum market that anticipates a rearranging of deck chairs in Nov. It seems that it will be not of much consequence to those shivering in the cold next Winter who becomes the new "Leader of the Free Money World".

2008 May 30 01:11 AM

[Cicero:]

Understanding macro-economics is vital to investing wisely. Most Americans think inflation is a complex array of economic forces that are in constant flux, with the Federal Reserve officials fighting gallantly to grasp and defend against them. In fact, this is a distraction to avert our attention from the simple reality that a group of private bankers, the Federal Reserve (they are not "federal" and there are no "reserves") is working in collusion with Congress to print money from nothing at essentially no cost and loan it to our government, charging us about 8% of our national budget in perpetual interest (we never repay the principle) for the privilege. It is to our financial ruin to ignore the man behind the curtain and see the great and mighty wizard in honest light. The ideas are simple enough for my high school economics class to grasp. Printing money inflates the supply and causes the value of the dollar to drop, just as adding more water to a pot of soup dilutes the (nutritional) value of each cup. This can all be verified on the Federal Reserve website in various speeches and in the NY Times. Ron Paul is virtually the only statesman in DC who understands this and is fighting against it.

Sources

Bernanke admits creating money from nothing in a speech on 11/21/02 on the Fed’s website: www.federalreserve.gov.../

The NY Times article “The Nixon Recovery” of 2/4/04 admits the fed prints or doesn't print money to sway elections: (query.nytimes.com/gst/...

The NY Time, article, "The Education of Ben Bernanke" admits the Fed created the housing bubble by pumping easy money in an effort to stem the damage of the dot.com bubble (that they fueled with easy money in the 90’s): www.nytimes.com/2008/0...
The article notes the Fed has “…control over the supply of money” and that this “…power to expand the money supply is unique... only the…Fed can create new money.”
The same article notes the Fed flooded the economy with easy money specifically to manipulate the 72 election for Nixon, creating the “brutal recession” and massive double digit inflation that marked the economic havoc of that decade. We learn that idle builders (my father was a carpenter) “were so enraged that some sent him two-by-fours in the mail.”

Bernanke admits Fed caused depression in the conclusion of this 2002 Speech here on Fed Website: www.federalreserve.gov...

2008 May 30 07:33 AM

[Cicero:]

Correction: It is to our peril NOT to see the man behind the curtain. Also, the article "The Nixon Recovery" in the NY Times also admits that the fed is independent of our gov't.

2008 May 30 07:40 AM

[SW Richmond:]

"We will print free money for you if in return you agree that we are in charge." The greatest banking power grab in history. Literally, trillions of dollars in collective banking power leveraged by one private bank. It's fricking genius. With the implicit threat: "If you don't do what we want we will kill your IB and sell it to one of our founders for two bucks a share." The carrot and the stick.

www.bloomberg.com/apps...

"Kohn Signals Wall Street May Get Permanent Access to Fed Loans"


So let the inflation begin in earnest. "We've got your backs, and with unlimited money. Now get your butts out there and stimulate the economy! Make some loans, do some deals, dammit!"

2008 May 30 08:22 AM

[jonathan:]

I think you guys are confusing currency and value. Currency is worth nothing, it is just a medium for exchange of value. You can price in Dollars, Oreos, Napkins or whatever you want. The real effect of inflation only occurs for the length of time it takes to turn the currency into something else of value.

So, if you are worried about inflation, don't hold currency. Simple. You shouldn't be holding currency anyway since it is valueless.

Buy companies, commodities, or land; or lend your currency to the bank at a rate equal to inflation (aka short term CD); or spend it. Money is just a convenience gents.

2008 May 30 10:01 AM

[PokerDonkey:]

Hey! What if the new currency was hot dogs!? Would you eat your money? I would! I'd eat it with relish and spicy mustard!

2008 May 30 11:13 AM

[nukldrager:]

Cicero... old news, bad news, and still news.
jonathan... Good point

2008 Jun 02 08:48 AM