If Asset Prices Are Dropping, Why are Bank Stocks Rising? http://seekingalpha.com/article/157510-if-asset-prices-are-dropping-why-are-bank-stocks-rising David P. Goldman August 21, 2009 My favorite indicator of bank portfolio quality, the traded price of riskier assets (in this case securities backed by subprime mortgages issued in the middle of 2007), has taken a big dip during the past couple of weeks: hat should be a surprise given 1) rising default rates, 2) poorer consumer performance and 3) more loan modifications with uncertain implications for bond holders. Iâve been calling attention to the cognitive dissonance between the jump in asset prices (mainly due to so-called Public-Private Investment Partnerships funded by the government with cheap leverage and an asset price put) and the underlying deterioration of asset quality. There was something of a mini-bubble in distressed asset prices driven by PPIP demand that seems to be abating. But what of bank stocks? WSJ this morning cites the failure of numerous regional banks who hold these securities. U.S. banks have been dying at the fastest rate since 1992, mainly because of bad loans they made. Now the banking crisis is entering a new stage, as lenders succumb to large amounts of toxic loans and securities they bought from other banks. Federal officials on Thursday were poised to seize Guaranty Financial Group Inc., in what would be the 10th-largest bank failure in U.S. history, and broker a sale of the Texas bank to Banco Bilbao Vizcaya Argentaria SA of Spain. Guarantyâs woes were caused by its investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nationâs worst lenders. The large banks own the same toxic waste. I have argued all year that they can squeeze out enough cash flow to keep one nostril above water, and that Citi (C) (for example) should trade around $4 a share just in terms of option value on a possible future recovery. But options can go wrong as well: we simply donât know how bad things are in the Citi portfolio. Bank stocks have rallied well past the level at which I am comfortable. I took profits too early, but there is a big enough risk of a relapse to keep me on the sidelines.