Bank Stocks Are Still a Sucker's Bet

"It's morally wrong to allow a sucker to keep his money"
-- W.C. Fields

With the largest government bailout of the banking industry in history on the way, and with most bank stocks trading at multiyear lows, is now the time for savvy investors to scoop up these stocks at bargain prices? From my perspective as a former banker, owning most banks stocks is still a sucker's bet and will be for at least another couple of years. Here's why.

Bank balance sheets, in general, are still toxic and will remain that way for many years, even with the government bailout. After the rupture of Japan's credit bubble -- which was arguably not nearly as bad as the one in the U.S. -- Japanese bank stocks didn't become a good investment for more than 12 years, despite massive government intervention to prop them up. Our credit bubble began to burst only a year ago, so this is very early in the process of repairing bank balance sheets.

There is a distress ratio for banks called the "Texas ratio." It was made famous in the 1980s by regulators who used it to predict which Texas-based savings and loans would fail next. If you apply this ratio to the self-reported portfolio data of U.S. banks, it indicates that nearly 1,000 banks should fail in the next two to three years. Since these data are self-reported by banks, it is probably too optimistic. Also, the data are generally one or two quarters old, and this crisis has been getting worse every month.

Cramer: Surviving Banks Aren't Sure Buys

Because only about 13 banks have failed so far in this crisis, this analysis suggests that the pain for bank shareholders has just begun. I can name just a few public banks, such as Corus (CORS), Downey (DSL) and National City (NCC), whose stocks are still trading as though they might survive, but these banks almost definitely will not.

Many more of these small to medium-size banks, public and private, will cease to exist in the next few years. Even Citigroup(C), although too big to fail, is not too big to have its shareholders wiped out, as we've seen happen at other behemoth institutions such as Wachovia (WB), AIG (AIG) and Washington Mutual (WM).

What about the so called "winners" such as JPMorgan (JPM), US Bank (USB), Wells Fargo (WFC), Bank of America (BAC) and Goldman Sachs (GS)?