Beware of the Behemoth

I was fortunte enough in 2000-2002 to watch with amusement many botched analyst recommendations. One prominent commercial bank put the Buy on EMC at 80, and then rode it down over a period of two years all the way to 3. At that point, they said that the fundamentals had changed, and they put the Sell on. Naturally, EMC slowly came back from that point. Never trust a commercial bank to get investments right.

But here's the scary thing: A big commercial bank is built to make money even when every important decision it makes is wrong. Incompetence in most areas does not mean that you should necessarily short it. Big banks are like out-of-control wrecking balls. Even though the operator may have left the control panel long ago, the ball will keep swinging wildly and knocking things down.

So the decision by Morgan Stanley to make Citi its number one short idea for 2008 is a curious one. Nobody doubts that there is probably more bad news to come out of Citi. Nobody doubts that the leadership of most investment banks and hedge funds could run circles around Citi's management team. Nobody doubts that you could take away 25% of its employees tomorrow and it would still be horribly bloated and inefficient. But to put a short on a major bank after it has already fallen nearly 50% in a few months is dangerous. Especially in a falling interest rate environment, where banks tend to do well.

Professionals lambasted commercial banks in 2002 and 2003 for their horrid mismanagement of investor portfolios. The major financial news sources had nearly an article every day about the wisdom of banks trying to manage money in the face of their own incompetence in this area. Yet, bank stocks rose tremendously during this time, even as they were pilloried in the media. The lesson here is that investment firms are built on brains, and banks are built on redundancies and safeguards. Morgan Stanley would do well to avoid the wrecking ball right now.