The Bubble of Bearishness, Part 2: Banks

This is the second part of The Bubble of Bearishness Bursts. Here is Part 1.

To say the fundamentals of banks and institutions have been challenged over the past year is an understatement. The action in the financials has dominated the trading for the entire stock market. In the first five months of 2009, the financial sector and the S&P 500 traded in the same direction 85% of the time.

Investors have been sucked into a "headline tape," a hysteria-filled environment in which everyone reads the headlines and nobody reads the news. Two popular misperceptions were spread throughout Main Street.

The first misconception was that the Troubled Asset Relief Program was intended as a bailout for every institution that participated. The goal of TARP was to ensure that banks have sufficient capital so that they can continue to lend during a downturn. Since some TARP participants received extraordinary aid, all participants were placed under the same black cloud. (The major banks receiving the most initial TARP funding were Bank of America(BAC Quote), Citigroup(C Quote), JPMorgan Chase(JPM Quote) and Wells Fargo(WFC Quote).)

The other misperception centered on "toxic assets." The large majority of losses incurred on collaterized debt obligations and other toxic asset-backed securities were taken in late 2007 and the first half of 2008. These losses were real and depleted the capital base of many financial institutions. As the recession and crisis deepened, the concern over "toxic assets" escalated.

Banks did still hold some CDO positions, but any position a bank originated prior to 2008 was a bad position because of the environment. The problem was that the word "toxic" was being applied broadly to all assets, as if they were all as risky as CDOs.