08/25/2010 10:51 pm ET | Updated May 25, 2011

More Tanking Ahead in Banking

The housing dousing just won't quit. As we all know, housing, the culprit behind the recent recession, was bombed again last month, with July's existing and new home sales -- versus those in June -- tumbling 27.2% and 12.4%, respectively.

One fella pretty much saw this coming. A few days prior to the release of those abysmal housing numbers, Michael Larson, associate editor of the Safe Money Report, a generally bearish investment newsletter out of Jupiter, Fla., fired off a commentary to subscribers in which he took note of the continuing real estate risks and also warned of more chaos in banking.

Given the timeliness of his astute real estate observations, I figured an update was in order. His views merit an especially respectful hearing, what with Larson -- a non-household name -- having sounded early warnings before most of the Wall Street herd about an impending credit crisis, a housing bust and a big decline in the stock market.

The last time I caught up with him he told me a double-dip recession was fast approaching (many say it's already here) and predicted the Dow would soon break its June low of 9,600 and wrap up 2010 at around 8,000. That's still his thinking.

So what bugs him about the banks, 114 of which have failed so far this year?

For starters, Larson, sees rougher days ahead for both banks and bank shares, pointing, in particular, to falling loan demand and mounting loan losses. Looking at an integral part of bank operations, the home mortgage business -- which he says is dead in the water -- Larson takes note that housing starts are stagnating in the well below average 550,000 range, while building permits just slumped to a 15-year low.

Further, the National Association of Home Builders' confidence index has dropped to a 17-month low, while the Mortgage Bankers Association's loan index is hovering around its worst levels since 1997.

Updating his thinking on commercial real estate -- which he views as an increasingly ominous risk for banks -- Larson points to a soaring number of souring CRE loans, up, according to the Federal Deposit Insurance Corp., a stunning 155% in the first quarter. Further, 17% of construction and development loans -- the bread and butter loans that banks make -- were non-current. That's more than double year earlier levels.

Equally alarming, observes Larson, is the shrinking demand for C&I loans, which, according to a Federal Reserve survey of senior loan officers, has shrunk at small banks for a record 16th quarter in a row. Further, demand at medium- and large-sized banks has fallen in every quarter but two over the past four years.

The tidings are equally ugly for banks in the all-important area of consumer credit (credit cards, auto loans and the like). It shrank 1.5% in the second quarter, bringing the cumulative decline to 6.5% since late 2008. The latest numbers show consumer credit is now at the lowest level in eight years.

Making bank problems even worse is margin shrinkage, namely collapsing net interest margins. Banks make a sizable chunk of their income by borrowing at lower, short-term interest rates and lending or investing at higher, long-term rates. When the spread between short and long rates is wide and rising, banks can coin money. But when it's narrow and falling, like now, it's the kiss of death; the profit then on each dollar lent or invested can collapse.

Meanwhile, slumping loan demand and souring loans have produced hundreds of bank failures over the past couple of years. And the problem, says Larson, is getting worse. For example, the FDIC now has 775 "problem" institutions on its watch list. That's more than double the 305 banks the FDIC was closely watching a year earlier.

What does it all mean? Larson's advice: Get the heck out of any financial stocks you may own. Ditto any other sectors vulnerable to a renewed financial and real estate slump, including real estate investment trusts.

Obviously, many investors are doing just that. Take the KBW Bank index of 24 leading U.S. banks. It can't get off the mat and recently collapsed to a multi-month low.

If you're tempted to go bargain hunting, the word from Larson is don't. His view: It's time to preserve assets, not gamble them away.

What do you think? E-mail me at