Editor's Rant: Get Sell-Side Foxes Out of the Henhouse

(Editor's Note: This story has been corrected to reflect the fact that Dick Bove's employer, Punk Ziegel, has been acquired by Ladenburg Thalmann).

A few weeks ago, my colleague Jason wondered aloud how anyone could possibly trust analysts who are tasked with judging their employer's rivals. He was speaking of the analysts who follow the likes of Goldman Sachs (GS - commentary - Cramer's Take), Merrill Lynch (MER - commentary - Cramer's Take) and Citigroup (C - commentary - Cramer's Take).

I responded that in the post-Spitzer era, firms are no longer able to pressure analysts to hold a particular opinion. And I added that any bad advice doled out would quickly tarnish an analysts' reputation, so they are inclined to look out for their clients' interests if they want to keep their big paychecks coming.

Now, I'm not so sure.

As the storm over Wall Street appears to have passed, it's fair to assess how well these analysts did. The short answer: lousy. Almost the whole group missed the Bear Stearns (BSC - commentary - Cramer's Take) debacle. Few were able to accurately predict the amount of capital-raising that would be required. For that matter, I don't think any of them anticipated the lousy quality of the subprime loans that were being peddled in recent years. So when it all blew up, many were caught off guard.

Two decades ago, financial stocks typically traded at a 10% premium to book value. In recent years, that figure reached 350% (though it has subsequently pulled back to 150%). Who benefited from the remarkable expansion in valuation? The employees of those firms, who generated huge gains from their stock options. Of course, bank analysts never follow their own firms, but the potential for back-scratching is axiomatic.

It's probably no coincidence that the "ax" in the sector is Dick Bove, who was employed by Punk Ziegel in recent years (which was bought Ladenburg Thalmann). Nobody thought of Punk Ziegel as a peer to these banking giants. It's also probably no coincidence that Bove is unique in his "out on a limb" assessments of the big banks. His estimates and opinions are often far from the consensus, while most of his peers hew to narrow -- and widely shared -- views. (A notable exception among the big bank analysts is Deutsche Bank's Michael Mayo, who has made a career of poking a finger in the eye of banks he follows.)

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David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.