Cramer on BloggingStocks: Banks are vital to the market's psyche

The problem is those banks and what they mean to the psyche of the market. We know, for example, that the government's not going to let any fail because Tim Geithner, who will be approved, knows (without ever admitting it) that when Lehman went under, we began to get the sickening sound of an industry cascading, one that now has banks down 50% from where they were before the Troubled Assets Relief Program money began to be distributed.

At the same time, not all of the bank stocks have been created equally. The banks that have not taken out their lows -- Goldman Sachs (NYSE: GS) (Cramer's Take) and Morgan Stanley (NYSE: MS) (Cramer's Take) -- are in particularly good shape compared with then, because they have much less to no mortgage exposure, although GS and MS were trading as if they have huge exposure to the custodian banks like State Street.

I know that Citigroup, PNC and SunTrust (NYSE: STI) (Cramer's Take) have similar asset-backed conduit problems that exploded on State Street. Bank of New York has asset problems too. But State Street has $23 billion in off-balance-sheet conduits used to manage other peoples' money and Bank of New York only has $4 billion. We don't know the true extent of PNC and State Street's exposure to these conduits, although they have from time to time told us not to worry about them. That's exactly what State Street had said. Citigroup? Always sui generis, as we have to believe that its off-balance-sheet conduits, which it has tried to put on balance sheet, are the worst of all.

PNC's situation is complicated, as is Wells Fargo's, because they bought banks where the bad loans were supposed to go to TARP. Even with the deal PNC got it is perceived as making a bad move, as is Wells with Wachovia.

All of this is to say that these banks are all candidates to have their common wiped out if they are going to be bailed out, which is what the market is saying. We see in Britain and Ireland that the common wipeout is taking place, and it feels like every bank over there is headed to AIG-dom, zombie-like, with receivership being the target.

What's needed is this. First, we need a cooling-off period where we can't destroy these banks' common through endless shorting through the use of the ProShares UltraShort Financials (NYSE: SKF) (Cramer's Take). (I suggest you read Eric Oberg's piece about this on RealMoney. He is the best there is.) Secondly, we need a solution where the government doesn't destroy the rest of the shareholders by injecting common stock in while preserving the companies' other securities.

Finally, we need to have the market recognize that the problems involve mortgages and off-balance-sheet exposure, something that we know Goldman and Morgan Stanley say they don't have and JPMorgan says is a problem, but a problem that can be dealt with.

In other words, we need some differentiation.

Differentiation was so hard to get Tuesday because we had cordoned off the custodial banks, which are not supposed to have a lot of mortgage exposure -- they are just supposed to be investing, not gambling -- and we discover that the cordon is bogus.

That then left the presumption that any assurances by any bank will be bogus, complicated, again, by the silence of the Fed and the lack of a Treasury head who could say, "We will invest in banks that make it so the problems can be handled and the bad assets absorbed by the government without subsequently wiping out the common if you can prove that you haven't bitten off more than you can chew -- Bank of America and Citigroup -- after plans were announced to have a TARP that would buy bad assets."

After all, I do not believe that people would be crushing the acquiring banks of Wells, JPM, PNC, and U.S. Bancorp (NYSE: USB) (Cramer's Take) if they had been able to put their acquired problematic whole loans to the TARP plan as it was originally conceived.

I distinguish Bank of America and Citigroup only because they have to be considered either legacy reckless, a la Citigroup, or actually misleading, a la Bank of America. They need AIG (NYSE: AIG) (Cramer's Take) treatment at this point, something that, if it isn't as bad at BofA and Citigroup as management says it is, won't necessarily be their destruction. In every one of these cases it is imperative, no matter what, that the government make it clear that the preferreds and corporate bonds will be honored, because that was the real crime of the Lehman destruction, not just common stock. Hopefully, the charmed Geithner, who will of course be approved, recognizes that.

Oddly, what might keep any further differentiation between good and bad banks from happening is, again, something that Oberg's been explaining: inclusion in the financial index covered by the SKF. If Goldman Sachs and Morgan Stanley, in reverse TARP-style, could simply buy Eaton or Illinois Tool (NYSE: ITW) (Cramer's Take), they would be saved from common stock destruction by being booted out of the index!

Ironic.

But true.

Random musings: I don't care for the Lennar (NYSE: LEN) (Cramer's Take) common stock, but it does seem like the SEC should investigate the Fraud Discovery Institute work by Barry Minkow. The Christopher Cox SEC subpoenaed me to see who I told when I told people to sell Overstock (NASDAQ: OSTK) (Cramer's Take) in the $50s on TV. I hadn't told anyone. They quashed the subpoena anyway. Minkow, according to Lennar, actually sold the information that he was going to put a hit job on Lennar. If true, shouldn't the SEC be following up on that transgression, considering that it might have done the same thing against Herbalife (NYSE: HLF) (Cramer's Take) than admitted it got it wrong? Right or wrong, anyone who profited from Herbalife made a lot of money. Or is it OK just to hit common stocks with fraud charges and then if things go down, so be it? Interesting case.

Jim Cramer is co-founder and chairman of TheStreet.com. He contributes daily market commentary for TheStreet.com's sites and serves as an adviser to the company's CEO. At the time of publication, Cramer was long BP, Goldman Sachs, JPMorgan, Morgan Stanley and Wells Fargo.