Why Financial Stocks Will Continue To Fall (FNM)(FRE)(LEH)(MER)(UBS)(WB)

Yesterday, a number of bank and mortgage company stocks began the day up sharply, with Fannie Mae (FNM), Freddie Mac (FRE), and Lehman (LEH) out in front. By the end of the day, most of these shares were in the red, regional bank stock prices has been decimated, and several firms including Merrill Lynch (MER) hit 52-week lows.

All of that is only the beginning of another leg down in the prices of banks, mortgage companies, brokers, and insurance firms.

Yesterday’s early-trading increases in financial share prices, a walk to the end of the rainbow, was interrupted by two things. The first is that it has begun to dawn on investors that all the money coming in to support these ailing banks and brokerage houses will not be free. If the federal government puts $5 billion into Freddie Mac, the dilution could easily cut the company’s share price in half. If Wachovia (WB) has to raise outside money, the effect will be similar.

The larger problem is that the market cannot avoid looking at the fact that the credit crisis is systemic. Shoring up trouble in one spot does not solve the problems in another. Even if Fannie Mae and Freddie Mac make it out of the crisis with their skins intact, firms like Lehman and Washington Mutual (WM) may not. Even overseas, banks including UBS (UBS) are in substantial danger of being dismantled or partially taken over by the government.

It may be simplistic, but financial shares are not going to trade up consistently until housing prices begin to rise and oil prices begin to fall. These two factors block the way to the overall health of the global credit system the way that the Colossus of Rhodes blocked the entrance to that ancient island. Oil is inflation, plain and simple. And, housing is recession.

Financial stocks can’t be rescued one at a time. The tide has gone out too far.

Douglas A. McIntryre