Superstar money manager David Dreman predicts the government will spend bags of money bailing out upside-down homeowners and big financial institutions in trouble with bad loans.
"Federal Reserve Chairman Ben Bernanke has a problem on his hands: a very wide-ranging panic surrounding financial institutions,” Dreman, chairman of Dreman Value Management, writes in a recent issue of Forbes.
"This is a problem that mere cuts in interest rates cannot cure.”
The panic is spelled out in the depressed prices for stocks of banks, securities firms and leveraged real estate investment trusts, Dreman notes. The Dow Jones Financial Index, which encompasses 289 companies in the sector, has plunged 26 percent over the past year.
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"Commercial and investment banks sitting on illiquid assets such as mortgages and private equity loans can’t sell them, and that means they don’t have the cash with which to make new loans,” Dreman says.
"The lack of liquidity is chilling the economy. Moreover, for banks and brokers to strengthen their balance sheets by deleveraging would devastate the economy and make what might be only a mild recession into one far worse and longer lasting.”
Financial institutions have suffered losses of about $300 billion so far thanks to the credit crisis, and the IMF estimates the losses will ultimately total more than triple that — to $945 billion.
Dreman, like other experts, sees this as the worst financial crisis since World War II. That’s why the Fed decided in March to allow securities firms to borrow from its discount window for the first time since the 1930s.
"The government is lending cash to financial institutions while taking as collateral the less salable of their subprime mortgages and related securities,” Dreman says.
"The financial middlemen are supposed to take the cash borrowed from the Fed and lend it back out again, this time to higher-quality borrowers.”
The plight of homeowners isn’t much better than financial institutions. Home foreclosures are running at a record rate of 8,000 per day.
So we’re just getting started on the cleanup, Dreman notes. "The government rescue of overleveraged financiers and underwater homeowners is still only beginning, and the signs that it will get bigger are manifold,” Dreman says.
"The Federal Housing Administration has spent $21 billion since September staving off foreclosures. And the House Financial Services Committee has proposed letting the FHA underwrite up to $300 billion in loans to borrowers,” Dreman points out.
So what are the implications for investors?
"First, we should see a big rally in the stocks of financial institutions that are survivors but are for the moment dirt cheap because of the market’s large overreaction,” he suggests.
"I’d look at Marshall & Isley and Fifth Third Bancorp. If you can take the heat of greater volatility, consider Comerica … which has a strong capital base and yields over 7 percent. I expect a rebound over the next several years.”
Dreman recommends against buying bonds because commodity prices will force inflation higher, in turn pushing interest rates upward.
Despite the general collapse in prices, he also sees residential real estate as a good value.
"If you don’t own a home or are thinking about trading up, now is a good time to make a move,” Dreman says.
© NewsMax 2008. All rights reserved.
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