2 Bank Stocks That Could Lead the Market Down

Short the Money-Center Banks

This whole mess started with the banks, and it ended with the banks. And it will start with the banks again.

As a group, American money center banks -- the institutions that lend money to individuals and businesses, not investment banks like Goldman Sachs (GS) -- are insolvent if regulators value the "assets" (in reality, debts or debt securities) at fair market value.

Fake stress tests, changes in accounting rules and incredible amounts of cheap money created by the Fed are keeping the system afloat, and rightly so. No ideology here -- what needed to be done was done.

Unfortunately for the economy, Washington is currently NOT doing what needs to be done, and that is recapitalizing the banks by removing toxic assets and increasing the core equity of the banks.

The system was saved from death, but many dead and dying banks were left alive, and are now zombies.

The Street has temporarily forgiven the money-center banks and run up their stocks, calling their legal-but-fake or one-time earnings gains the first green shoots.

What could trigger another banking meltdown?

n January 2010, banks must put their off-balance sheet assets on their balance sheets.

My translation: Assets that were not good enough or too leveraged, and therefore kept off balance sheets, will be put on the books. Regulators and the Street will do new calculations as to the amount of core capital and equity each bank requires to support their balance sheet.

Depending on how you interpret the almost unreadable footnotes in their financial statements, Citigroup (C) has between $1 trillion and $1.2 trillion of these assets, and Wells Fargo (WFC) has $1.5 trillion to $1.8 trillion. When these assets get put on the books, their capital requirements will soar.

Over time, shareholders will be diluted as the banks raise capital, and this could happen even if all the assets were in great shape.

Want to see for yourself?

Check out page 21 of Citigroup's town hall presentation from November 2008, which can be found on Citi's Web site. And have a look at footnote seven of Wells Fargo's most recent quarterly filing with the SEC -- of course, it is many pages long.

So, look for the bank stocks to be the ones to start dragging the market down, most likely ed by Citigroup and Wells Fargo.