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Back When ...


People often ask themselves: "Why didn't I buy X back when ...?"

"X" could be a lot in Brooklyn or a Louisiana oil well --or a Warhol print or a Malibu beach house.

It could also be a share of IBM in 1994 when Big Blue was in the gutter, up 882% since then. Or a share of Citigroup in 1991, up 1,319% since the last financial and housing crisis (even after its recent collapse). Those numbers aren't typos.

So why don't people buy X when they have the chance? The current financial panic answers that question. At the time of greatest value, such purchases always appear the most dangerous, even ridiculous. At such inflection points, all confidence is lost and assets are thrown away at loony prices. Does anyone know anyone who believes a bank stock will ever go up again? The fear of freefall is enough to make people sell any bank -- not just the ones that won't survive -- even when doing so is based on fear, not fact. Here lies the opportunity.

Some will wait for recovery to show its face. Though by then, stocks will have huge run-ups, since equities price in recovery long before it occurs.

The current crisis is bad enough to doom many lenders. Indymac is already gone. Hundreds of smaller banks will probably close, just as a thousand did during the Savings & Loan Crisis of the early nineties. A few more big ones could disappear; for example, Washington Mutual looks precarious. But the vast majority of large, well-capitalized, money-center banks will not only survive, they'll thrive. The strong will seize deposits and market share from the weak. The strong will buy the weak at bargain prices. The strong will benefit (as State Street reported in its earnings today) from the steepened yield curve.

The trick to investing in crisis is thorough triage: sorting the survivors from the damned. Quality institutions like American Express, Citigroup and Chase are being sold off along with the rest, but these three companies have tremendous future earnings potential and access to capital. [Full disclosure: I own all three personally and for clients, both through the Fund I manage and through mutual funds in client accounts]. I bought all three too early and have lost money so far, but I expect those losses will be eclipsed by eventual recoveries.

These lenders have tremendous deferred earnings power and vast international operations. By any metric, whether by discounting expected cash flows, assessing multiples to earnings or tangible book value (after stripping out problematic Level 3 assets and inflated goodwill) -- and even after adjusting for collapse in securitization, recession charge-offs, continued write-downs, further dilution and reduced dividends, these stocks look cheap. To be good investments, they only have to survive. And if these three don't survive, we'll all need to run for the hills with shotguns tucked under our arms. An allocation among stocks, bonds and cash will be the least of our problems. It makes more sense to invest for the probability that the world will outlive this collapse -- as surely as it did all others in history -- instead of for the remote possibility that the apocalypse is finally upon us.

Other pitfalls remain in the financials: Fannie Mae and Freddie Mac could be nationalized, Lehman could be taken under or suffer a massive run like Bear Stearns. There are other stocks to avoid, like weak regional banks and undercapitalized insurance companies. But quality will be priced accordingly, eventually. When it does, you'll want to say: "I bought X back when..."