Be Careful with Banks: Credit Downgrades are Imminent

Banks rallied nicely on Friday: the BKX bank index jumped 3.98%, JP Morgan (NYSE: JPM) was up 5.9%, Bank of America (NYSE: BAC) was up 4.5%, Goldman Sachs (NYSE: GS) was up 3.3%, and Morgan Stanley (NYSE: MS) was up 5.7%. But don’t be a sucker: the new financial regulation bills will lead to credit rating downgrades this summer.

For those who did not spend the weekend reading 1400+ pages of the Restoring American Financial Stability Act of 2010, there is one important area which requires your caffeinated attention:

The Dodd-Frank Bill directly addresses government bailouts of financial institutions. If the government is no longer an implied guarantor of these institutions, their credit rating will drop like a 22-year old who can no longer rely on mommy and daddy to co-sign for every little venture. Once the ratings start dropping, stock prices will follow because financing costs will rise.

Don’t get sucked into placing long bets on your financial horses. The lower risk play is to wait and see whether Uncle Sam will continue bank rolling the adventures of our Wall Street banksters.

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