Many see the fire sale of Bear Stearns to JPMorgan Chase as the first horsemen of impending financial apocalypse but, more than a week since these events, it may be prudent to look at Bear Stearns and financial stocks in a discerning light and removing the sheer panicked tones that surrounded the reporting of the event.  Lest one stock up on military rations believing our stock market will send us all into ruin, let’s remember a couple of things.

• Bear Stearns couldn’t get out of its problems because it wasn’t a deposit taking bank. I am not going to admit to knowing in precise detail the collapse of Bear Stearns but its fundamental problem wasn’t a lack of money; more precisely, it was they didn’t have any short term money lying around. All their money was tied up in either bad commercial paper or financial commitments which could not be paid back fast enough. Think of Bear Stearns as a trust fund kid who owes a lot of money to the wrong people but the trust isn’t going to give him his trust entitlement until he’s 25- and he’s 23…which means he’s about to have his knee-caps broken. Deposit taking banks can at least rely upon the fact it can use deposits to fend off any short term cash crunches. The investing lesson? As I blogged about before, invest in banks that have good retail operations. Think of banks like Wells Fargo, RBC, Bank of America (not a recommendation; for disclosure, I own RBC). At the very least, they can use our deposits to buy their way out of their stupidity.
• Banks don’t go under. We keep them afloat. Regardless of whether central banks have private interests or non-private interests sitting on the board, the results are the same. At the end of the day, the government will always bail out the banking system and the damage will always contained- something that cannot be said for every industry. Whether it is through nationalization (England and Sweden) or other relief (what the Federal Reserve is doing now), the central banks will use taxpayer money to maintain the integrity of the system. Yes, the risk has shifted from the banks to the taxpayer and, while the banks may have averted disaster, the cost to you and me is most likely government induced inflation and less money to fight deficits or pay for programs (makes you wonder if you might as well buy bank stocks since the central banks are taking money out of your pocket and indirectly putting them into the banks; at least with a dividend from a bank stock, you get some of your money back).
• A lot of babies got thrown out with the bath water. There are banks who have little to no exposure to subprime or ABCP that are collateral damage to the selling of financial stocks in the market (exhibit A: TD which I own). Insurance companies and mutual fund companies, with little to no exposure to subprime or ABCP, have been swept up in the selling of bank stocks. Remember not to paint the entire industry with the same subprime brush when looking in the bargain bin. Look for stocks with little subprime exposure that have a history of timely and full disclosure to shareholders.
• Its not over…this is a multi-trillion dollar problem and billions are being thrown at it (an analyst wrote earlier this week that subprime may take 2.5 years to completely unwind itself). Plus… the banks got off too easy. The Federal Reserve bailed them out relatively quickly so I am not sure if they learned their lesson. They may go back and think of some new exotic financial instrument to shoot themselves in the foot (never under-estimate smart people to be too cute by half). As I said above, look for banks that adhere to the KISS principal in order to ensure some safety cushion.
• Nature abhors a vacuum. One of the more interesting phenomenons occurring is that non-financial stocks are raising their dividends to attract money that once went to the financial stocks (look at General Mills, Encana, Rogers and Harley Davidson(!) raising dividends in higher than historical fashion as examples). The good thing about the financial melt-down is that other companies are rushing into the breach as alternatives for investors to put their money.

If you believe that now is the time to buy financial stocks (and I am not going to predict whether it is or not- just remember even an “expert” like Jim Cramer has put his foot in his mouth recently over financial stocks), look for fundamentally sound companies- good cash flow, good deposit taking institutions, management committed to full and timely disclosure, lots of revenue streams (retail banking, credit cards, M&A, wealth management) and the dividend payout ratio is relatively low (under 40% ideally)- to let you sleep at night. For specific stocks, some other bloggers have looked at:

• Citigroup by See Me Get Rich
• BMO by the Money Gardener
  
• Bank of America by the Dividend Guy
• A collection of research at Canadian Banks and Insurance