Will Financial Stocks Clean Up? 1

By Ben Steverman

A couple of weeks ago, it seemingly couldn't get any worse for financial stocks, particularly banks. Equity prices hit decade-plus lows because many investors genuinely worried certain bank stocks were worthless—either because the banks were doomed or because the government would take them over.

But sentiment on Wall Street can turn on a dime these days. Stocks, particularly financial stocks, surged on Mar. 23, and the reason most commonly cited was the release of details of the U.S. Treasury's plan to set up a public-private partnership to buy up toxic assets—and remove them from banks' balance sheets. The KBW Bank index (KBX) jumped 18.6% in one day.

But investors who are buying more financial stocks—sometimes for the first time in years—say they're not jumping into the risky sector based on one government plan.

One Piece of the Puzzle

The Treasury's effort is just one part of the solving the subprime puzzle, says Michael Sheldon, chief market strategist at RDM Financial Group. "The plumbing of the financial system is slowly being put back together, piece by piece," he says.

The first signs of springtime for banks appeared a couple weeks ago. On Mar. 10 the head of one of America's most troubled big banks, Citigroup (C) Chief Executive Vikram Pandit, told his employees he was "most encouraged with the strength of our business so far in 2009." He said the bank made a profit in the first two months of 2009.

Whether investors adopted Pandit's rosy outlook or not, his comments reminded investors of one thing that has almost certainly true: If it weren't for all the pesky losses from what the Treasury calls "legacy" assets—the soured derivatives haunting banks' balance sheets—this would be a good time for the basic banking business.

The Federal Reserve has cut short-term interest rates to nearly zero, giving banks a big advantage: They can borrow at low rates and then lend at higher rates, giving them some of their widest profit margins in years.

A Cheery $1 Trillion

A week after the Pandit memo, the Fed said it would devote more than $1 trillion to buy up debt, an effort to perk up credit markets. Financial stocks rose again.

Then, on Mar. 23, the market celebrated new Washington policy again, a huge contrast to its disappointed reaction to Treasury Secretary Timothy Geithner's first attempt to announce a plan to deal with toxic assets on Feb. 18. Back then, Geithner was criticized for being vague and lacking details.

But while the Street seemed positively ebullient on Mar. 23, there are still plenty of doubters. To say there are still unanswered questions is an understatement. And many observers criticized this plan, too, saying it was un-workable or too generous to banks.

But for the first time, says Dan Genter, president of RNC Genter, "everyone is saying, 'Fine, we're at least moving in the right direction.'"

There's no simple way to fix the financial crisis, Genter says. But the basic details of Geithner's new plan remove a major fear: "The major concern," Genter says, "is that the Administration was going to make it worse."