Does Wells Fargo Mean Banks Are Back?

Donald Luskin

You've just got to love Wells Fargo (WFC: 19.61, +4.72, +31.69%). Before the opening yesterday, Wells pre-announced first-quarter earnings of $3 billion, twice Wall Street's expectations. The stock jumped more than 31%, powering stocks overall to almost a 4% gain on the day and breaking the major averages out of a five-month downtrend.

The S&P financial sector is now up more than 75% from its lows just one month ago. I've been saying that a recovery in the banks is the key to turning the market and the economy around. Now, maybe we've got a chance.

But really, it's not just what Wells Fargo did yesterday. You've got to love the way Wells did it. The big driver of the bank's unexpected profit surge was its acquisition of Wachovia — the bank that failed last summer under the crushing weight of its own misguided acquisition of mortgage lender Golden West Financial. In Wells' hands, though, what everyone thought was a toxic asset waste-site turned out to be a gold mine.

And do you remember how Wells happened to acquire Wachovia? It's too beautiful to forget, so let me remind you.

Last September, Wachovia was the last domino to fall in the horrific sequence of financial firm failures — Fannie Mae (FNM: 0.74, +0.06, +8.82%), Freddie Mac (FRE: 0.77, +0.07, +10.00%), Lehman Brothers, Merrill Lynch, AIG (AIG: 1.16, +0.08, +7.40%), Washington Mutual, and finally Wachovia. The Federal Deposit Insurance Corporation forced its acquisition by Citigroup (C: 3.04, +0.34, +12.59%). The deal was that Citi would pay a measly $1 per share of Wachovia, and the FDIC would invest $12 billion and insure Citi against any losses above certain threshold.

Then Wells came on the scene. It offered to buy Wachovia for $7 a share and told the FDIC that it didn't need any investment or any guarantees. Believe it or not, Citi had the gall to sue to block Wells' offer even though in every dimension it was superior for Wachovia stakeholders and for the American taxpayer.

You have to wonder what the FDIC was thinking in the first place. Citi had to take two huge capital injections from the U.S. Treasury under the TARP program in order to survive, and it had to have the Federal Reserve guarantee $300 billion of its toxic assets. So what was the point in having a bank that screwed up take over Wachovia?

Inquiring minds want to know. Maybe Wachovia wasn't in trouble at all in September. Maybe it was always the diamond in the rough that it now so clearly is in Wells' hands, and the whole idea was really to prop up Citi with Wachovia, not prop up Wachovia with Citi.

But Wells messed up that nice little conspiracy. It's always had an eye for value. In fact, I worked for Wells for a decade and witnessed first hand dozens of its bank acquisitions, every one of which was priced right and executed brilliantly.

And Wells has always been conservatively managed. Through most of the current banking crisis, it enjoyed the reputation of being one of the few major banks that hadn't blown itself up with toxic mortgages. But in the last couple horrible months, investors have forgotten about making distinctions between good banks and bad banks. They're all horrible, even Wells.

And it was easy to think so because of the Wachovia acquisition. People who didn't really know anything about Wachovia's business — except that they could throw the word "toxic" around to make themselves sound smart — could tell themselves that Wells had overreached and made too risky a buy. But Wells showed 'em.

But no good deed goes unpunished. Back in October when Treasury Secretary Henry Paulson first implemented the new TARP program, he forced every major bank — including Wells — to take TARP money whether they wanted it or not. Wells Chairman Richard Kovacevich told Paulson no, but the Treasury Secretary said it was Wells' patriotic duty to take the taxpayers' money like all the rest. So Wells played the good soldier and took the money.

And now it's sorry it did. Now, because it took government money it didn't even want, its executives have been made subject to new compensation restrictions enacted by Congress and enforced retroactively. The idea was to make sure that the risk-happy fools who created the financial crisis in the first place now don't benefit at taxpayer expense — but surely Wells shouldn't be punished: it was one of the good guys.

Wells' Kovacevich isn't shy about complaining. In a speech last month, he said "Is this America — when you do what your government asks you to do and then retroactively you also have additional conditions? If we were not forced to take the TARP money, we would have been able to raise private capital at that time."

Kovacevich isn't fond of the Treasury's latest rescue schemes either, especially the "stress tests" to be applied to the 19 largest banks including Wells. He said, "We do stress tests all the time on all of our portfolios. We share those stress tests with our regulators. It is absolutely asinine…"

I've said pretty much the same thing myself. But for me, it's a cheap shot. I have nothing at stake. Imagine the courage it takes for the chairman of a highly-regulated business to call his all-powerful regulator "asinine." That's serious guts.

So call me sentimental. When I worked for Wells, I had a license plate frame that said "My other car is a stagecoach." Now, more than a decade later, I have a painting of a Wells stagecoach in my office. It's a great company, and I'm proud to have been associated with it.

And Wells Fargo's triumphant earnings announcement yesterday made me prouder than ever. I don't want to let my own nostalgia get in the way of my judgment, but I have to say I'd just love it if this, of all things, turned out the be the all-clear signal for the banking system, which would then be the catalyst for economic recovery.

But let's not leap to conclusions. After all, should we really be surprised that the best-managed bank in America had great results? That doesn't mean that all the other banks will.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.