Banking-Stock Paired Trade: JPM, WFC

Knowing that banks are in business to collect money, not own homes, neither option was appealing. Last week JPM unveiled the first step in a process that both limits negam and prevents further foreclosures.

Last Friday, JPM announced its intent to modify $150 billion of mortgage loans. While details are limited, we can expect some combination of lower interest rates and reduced principal balances to help homeowners obtain a monthly payment they can afford. The greater affordability will allow people to remain in their homes, will stem the tide of foreclosures and should eventually provide support to the housing market.

Personally, I do not like the path that massive loan modifications represent. By reducing loan balances and interest rates, bankers are penalizing prudence and rewarding speculation. While I could write pages on how this will only cause future problems, doing so would be a pointless exercise. As investors, our job is to predict actions, determine their effect and decide how to profit.

Looking back to the mortgage bubble, three main lenders were seen making questionable loans in mass size. These lenders were Countrywide Financial, Golden West and WaMu.

Today, Countrywide is part of Bank of America (BAC Quote), WaMu is part of JPM and Golden West part of Wells Fargo (WFC Quote) via its merger with Wachovia. With JPM's modification intentions, we can expect that BofA and Wells will have to follow suit. Maintaining high mortgage payments when your competitors are reducing them is politically unpalatable.