3 Financial Headlines You Can't Ignore

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

News about financial stocks is truly the theater of the absurd. I could never have imagined it, and I would never have predicted it.

Since their outcomes are unpredictable and unimaginable, it is reasonable for investors to swear off financial stocks altogether. Investors who cannot bring themselves to abstain from an entire sector should only allocate very small amounts of capital to what are clearly speculative bets.

AIG Considering Suing based on Bailout

American International Group (NYSE: AIG) has taken absurd to new levels by considering suing the U.S. government for bailing it out. Understandably, this has attracted criticism from lawmakers and citizens following its deliberations on whether to join a suit against the government that seeks to establish that its 2008 bailout was unconstitutional.

The suit was tabled by Maurice Greenberg who previously served as the company’s Chief Executive Officer and who has investments in one of AIG’s shareholders, Starr International. Greenberg insists that the bailout was not constitutional, it resulted to a dilution of investor’s stakes and the government is charging exorbitant interest rates to the companies that were bailed out. The suit that has been filed as Starr International Company v. U.S. earned the judge’s approval to continue with the underlying facts indicating that equal protection by the law and other constitutional rights of shareholders had been violated. The current Chief Executive Officer Robert Benmosche cited the company’s duty to assess the claims and respond appropriately. According to Benmosche, The board of directors has fiduciary and legal obligations to the company and its shareholders to consider the demand served on us.”

AIG may choose to join the suit, give Greenberg the go-ahead or stop him from pursuing the case, but the company is still holding board meetings and weighing its options. According to AIG, “It is the AIG board’s obligation and intention to consider seriously Starr’s demand and respond to it in a manner that the board believes is in the best interest of the company.”

The board has sought opinions of various people including Representative Peter Welch who believes that it would be reckless to take over the claims and continue with the suit. According to Welch, “Taxpayers are still furious that they rescued a company whose own conduct brought it down.” Most Americans would find AIG joining the suit against the government ironic since they feel that the taxpayers did AIG a favor by investing $182 billion in the troubled firm to keep it out of bankruptcy. What’s even more amazing, the company has also initiated an appreciation campaign to thank taxpayers for the bailout and deciding to sue their benefactor may not go down well with investors.

500,000 Seek Reviews of Foreclosures

You may think that circumstances surrounding the bailout are rare and are of no consequence going forward. Bailouts do happen, but they are not commonplace. There are bigger threats to going concerns of financial companies as their contracts are becoming subject to judicial and political risks.

According to a report by the U.S Office of the Comptroller, some 500,000 foreclosed borrowers are seeking formal reviews for the period between 2009 and 2010. Bryan Hubbard, an OCC spokesman said, “A significant amount of effort was made to increase awareness during the fourth quarter of 2012, and that’s reflected in the increase in the number of people who requested a review.”

Info obtained from undisclosed persons indicates that state regulators are planning to shift from the current victim-by-victim refund system and implement a $10 billion flat fines scheme.  Fourteen of the largest mortgage service providers which include JPMorgan ChaseCitigroup, and Bank of America were instructed by bank regulators—including the OCC—to sort out their foreclosure practices in 2011. JPMorgan, Citigroup and Bank of America were required to hire independent consultants to assist them in this exercise and to determine whether correct procedures were followed when dealing with customers. If found to have engaged in malpractice, JPMorgan, Citigroup and Bank of America would be required to pay lump-sum payments ranging from $500 to $125,0000 for each malpractice discovered. There is considerable uncertainty regarding the amount of payments people would have received in the current system.

You may think that every mortgage agreement should require personal review by two lawyers, one from the bank and other representing the borrower. I think this would be ridiculous and expensive. However, it is clear that the substance of mortgages and the repercussions of delinquency are under attack. Borrowers who were aware of the payments they contractually were required to make are being granted more and more lenience once they fail to make them. Collections has been and will be ugly, but that’s what protects lenders. Maybe that gives you a warm fuzzy, but that makes lending a more treacherous business. Bank stocks are worse off for challenges to their ability to liquidate their collateral.

HSBC Settlement

Banking itself is highly regulated and failure to comply with regulations can lead to material fines. Recently, the U.S. Department of Justice and HSBC (NYSE: HBC) agreed to settle over money laundering. The settlement was huge: HSBC will pay roughly $1.92 billion. To date, this is the largest settlement payment of its kind paid by a bank, exceeding Netherland’s ING Groep’s (ING) $619 million last June for similar penalties.

Investigations discovered HSBC’s failure to comply with anti-money laundering review which resulted in trillions of dollars in wire transfers passing through U.S. bank accounts for Mexican illegal drug transactions. U.S. Treasury Undersecretary David S. Cohen said, “Despite the well-known illicit finance risks associated with Mexican drug trafficking organizations, HSBC inexplicably placed Mexico in its lowest possible risk category.  As a result, it allowed billions in wire transactions and bulk cash to pass through its gates with minimal if any monitoring.”

HSBC became a means for black-listed nations and organizations circumvent economic sanctions. About $660 million in Office of Foreign Assets Control’s prohibited transactions moved through U.S. financial institutions from countries with economic sanctions such as Iran and Cuba by using HSBC. The numbers were huge:  HSBC processed $430 million from 2,300 transactions that transpired between March 2004 to June 2010 which violated economic sanctions imposed against Iran, Cuba, Libya, Burma and Sudan.

Conclusion

The future of any given financial stock is too hard to imagine or predict. It is best to stick to sectors where fundamental analysis will give you an edge instead of diving into uncertain financial stocks.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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