It wasn’t too long ago that a bad bank just meant one with long lines, rude tellers and high fees. But times are changing and the definition today is completely different.

These days, the Obama Administration is putting together a plan to set up a so-called “bad bank” to clean up the many toxic loans eating through the American financial system. Doing this would effectively remove those loans from individual financial institutions’ balance sheets… and put them in the hands of the U.S. government instead.

Similar to the Resolution Trust Company that bought and disposed of failed savings and loans companies during the 1980s crisis, what the Obama administration hopes to do is put banks back in the position where they feel comfortable lending again. And once consumers are able to acquire loans, they’ll start spending and the economy can start growing once again.

It sounds like a solid idea, and if it works, some financial stocks could rebound.

So what should investors do?

The answer is: not a darned thing.

When A Bad Bank is Just A Bad Bank, And A Crisis Is Just A Crisis

While it’s true that crisis often brings opportunity, that doesn’t mean that you should blindly throw money at every catastrophe you hear of. Good investors understand both the risks and rewards of any venture they go into. In fact, the best investors focus more on the risk part of the equation than the reward.

And this is one crisis that bears careful scrutiny. Because right now, it’s impossible to understand the full risk in investing in the financial sector. There are simply too many questions that don’t have ready answers.

• Will the banks be nationalized?
• Which banks will emerge clean and ready to conduct business?
• Which ones won’t?
• Will they bear any responsibility for the garbage loans they underwrote?

Could financial stocks rip higher on any settlement of the issue? Of course they could! But prudent investors looking for real wealth-creating opportunities should stay as far away from the group as those families earning $50K per year should have stayed away from the interest-only $500,000 variable rate mortgages they can no longer pay.

Remember: If it sounds too good to be true, it probably is.

**********

Poor Statistics Continue Pouring In

The assault of statistics we’re bombarded with every day illustrates a picture-perfect, hindsight example of that… and they’re getting worse.

• More than 1.3 million Americans have lost their homes
• 6.9% of prime jumbo loans are at least 90 days delinquent, up from 2.6% a year ago
• 25% of prime jumbo loans are for more than the home is currently worth

I emphasize the word “prime” because it’s important to understand the specific kinds of loans that got us into this mess. Those prime loans weren’t mortgages handed out by reckless brokers to people with shaky credit and low incomes. The prevailing thought was that the mortgage crisis was a sub-prime problem.

Now it appears broader in scope.

If the Feds decide to set up this Bad Bank program as they seem likely to, I certainly hope it works. For that matter, I hope all of the other tactics we implement in the coming months work as well: stimulus packages,tax cuts, exorcisms, fire walking, and worshipping the Chinese God of Wealth, General Kuan Yu.

But while I’m hoping for good results in the future, I’m also keeping a wary eye on the here-and-now. I don’t believe that there are any “good banks” in this environment. Or at least there aren’t any good enough to offset the risk of all of the unknown factors facing the sector.

So for the time being, I highly recommend leaving playing around with the financial system to the Feds; find some other place to invest in the meantime.

**********

Forget Financials… Healthcare Is Looking Better Than Ever

If you’re looking for ideas, I believe healthcare will be the best performing sector in the market. We’re seeing consolidation in the group, which should garner higher profits as time goes on.

Pfizer (NYSE: PFE) recently announced a $68 billion acquisition of Wyeth (NYSE: WYE), while Swiss-based Roche Holdings is reportedly out talking to banks about obtaining a loan to complete its $44 billion buyout of Genentech (NYSE: DNA).

Additionally, you have biotech companies with rich pipelines that are starting to bring product to market, and an aging population that will require more medicines, procedures and services.

Look for companies that have lots of cash and little or no debt.  You don’t want to own companies that need to raise capital in this environment. Or, if you’re not sure which companies afford the best protection while simultaneously offering the highest returns, you can check out my service Access Research Group, which recommends small biotech companies with big potential.

Source: The Good Bank/Bad Bank And The Ugly