Gordon Gets It Right

Among the companies featured here are J.P. Morgan Chase (JPM - Analyst Report), Citigroup (C - Analyst Report), Morgan Stanley (MS - Snapshot Report), Bank of America (BAC - Analyst Report) and Goldman Sachs (GS - Analyst Report).

Finally there is some good news on the world financial scene. Over the weekend, the finance ministers of the leading economies in the world basically agreed to follow the plan developed by Prime Minister Gordon Brown and Chancellor of the Exchequer Alistair Darling to directly inject cash into the balance sheets of the major banks and take major equity stakes.

The U.K. government will now own about 60% of the Royal Bank of Scotland (RBS - Analyst Report) and about 40% of the combined Lloyds (LYG - Analyst Report) and HBOS (HBOS).

The second element of the plan was to guarantee loans between banks. This should free up interbank lending and in turn free up lending to the real economy. Think of it this way -- the first part of the plan fixes the engine of the economy, the second part fixes the transmission. The European Union is following suit, and from his comments last week it is clear that Henry Paulson has come to his senses and will be doing something similar here with the $700 billion bailout package.

The direct equity injection plan hits the key objectives of any bailout plan. It stabilizes the banking system. Banks with solid balance sheets are capable of lending to credit-worthy corporations. The key problem with the banks has been that they have too much leverage, and as they sold off assets to de-lever, the prices of those assets fell.  Since everyone was doing so at the same time, and leverage actually increased as a result.

Direct injection of capital is literally an order of magnitude (i.e. better than 10x) than buying assets on a per dollar basis at fixing bank balance sheets. Since the government will own preferred stock, the taxpayers will share in the upside of the recovery, and there is a very good chance that over the long run (say five years) we will end up making money out of the deal.

The prospects for taxpayers actually making money from the original bailout plan were extremely remote (although not all $700 billion would have been lost, a good chunk of it probably would have been). The chance of taxpayers actually making money in the plan floated recently by one of the major presidential candidates to buy mortgages at face value from the banks and then renegotiate better loan terms with the homeowners was exactly zero. The chances for making money under the equity injection plan are excellent.

Put it this way -- at Friday's closing prices, the government could inject a sum equal to the current market capitalization (thus giving the taxpayers a 50% stake) in Citigroup (C - Analyst Report), Bank of America (BAC - Analyst Report), JP Morgan (JPM - Analyst Report), PNC (PNC - Snapshot Report), Marshall & Ilsley (MI - Snapshot Report), BB&T (BBT - Analyst Report), U.S. Bancorp (USB - Analyst Report), SunTrust (STI - Snapshot Report), Comerica (CMA - Analyst Report) Fifth Third (FITB - Analyst Report), National City (NCC), Keycorp (KEY - Analyst Report) and Zion Bank (ZION - Analyst Report) -- not to mention Morgan Stanley (MS - Snapshot Report) and Goldman Sachs (GS - Analyst Report) -- and still have well over $100 billion left over from the $700 billion authorization.

Such a move would punish the existing shareholders of these banks by diluting them, and I imagine that the government would order the suspension of all common dividends for a period of several years. That, however, is a good thing -- shareholders of companies that make bad decisions are supposed to suffer.

I would continue to avoid the banking and financial names, as well as the consumer discretionary names. There are far too many good stocks that will be relatively unaffected by the coming economic slowdown that have been beaten up to choose from in here. Look at the Big Pharma companies, the Consumer Staples and the Energy sectors; there is more than enough in those three areas to choose from.

Read the full analyst report on LYG.

Read the full analyst report on BBT.

Read the full analyst report on USB.

Read the full analyst report on CMA.

Read the full analyst report on FITB.

Read the full analyst report on NCC.

Read the full analyst report on KEY.

Read the full analyst report on ZION.