August has not been a good month for the financial markets. Economic fears about Greece, Ireland and Portugal have expanded to include Italy, the third largest Eurozone economy. With debt around 120 percent of GDP and economic growth prospects looking weak, the yield on Italian bonds has risen sharply this month to 6.26 percent, according to a Bloomberg report, to reflect the added risk. Riots in England and talk of proposed regulations by the Independent Commission on Banking, which include “ring fencing,” or separating the retail side from the investment side of British banks, contribute to continental uncertainty.

In the United States, unemployment remains stubbornly high at about 9 percent and housing markets are still weak with more than nine months of supply. The Purchasing Managers Index has fallen to 50.9 for the month of July. Any score above 50 indicates economic growth while under 50 represents contraction. Last month’s 50.9 represents somewhat anemic growth in comparison to the 57.3 12-month average.

Fears that U.S. political leaders couldn’t do enough to decrease the deficit caused rating agency Standard & Poor’s to downgrade the U.S. credit rating from AAA to AA+, reflecting a higher risk for U.S. Bonds. Overall, fears of a double-dip recession, or at least a sluggish economy coupled with the European sovereign debt crisis, caused markets to sink. The Dow Jones Industrial Average is down 15 percent and the S&P 500 fell 14 percent this month. Turns out the folks who heeded the old Wall Street saying “sell in May and go away” for the summer were right.

Some of the biggest losers this month were bank stocks. Shares of JPMorgan Chase are down 14 percent and Wells Fargo is down 17 percent, while Citi and Bank of America are down 28 percent. Bank stocks were hit hard for several reasons. First, general macro factors such as high unemployment or the uncertainty surrounding the U.S. deficit impact all stocks but especially equities in the financial sector. Secondly, historical precedents make investors leery of financial stocks. In the 2008 financial crisis, banks were punished because they lacked capital reserves to cover their liabilities. Because people were burned in the past, they are less likely to invest in bank stocks, especially during the present uncertainty.

Banks are also feeling pressure on their net interest margins. The net interest margin is the difference banks pocket between the cost to borrow money and the rate at which they can lend money. The downgrade of U.S. debt might push interest rates higher to reflect additional risk despite the Federal Reserve pledging to keep rates low through 2013. Also, the weak economy and high unemployment force low rates on bank loans. These two forces at work squeeze the NIM by potentially making it more expensive for banks to get money while receiving less interest from the loans banks issue. On the aggregate, U.S. banks have seen their net interest margins decline from 3.52 percent to 3.4 percent. Banks are also facing lawsuits regarding mortgages. For example, insurer AIG is suing Bank of America for $10.5 billion for failure to disclose the riskiness of the mortgages AIG bought from them.

Despite these headwinds, U.S. banks represent promising investments for the investor with a long-term time horizon. Wells Fargo and JPMorgan are initiating share buybacks, which show these companies have a strong asset base. As other banks strengthen their balance sheets, they too should be able to start buying back stock or increasing their dividends.

Unlike the situation during the last banking crisis, capital reserves at banks are high. The Tier 1 (core capital) Ratio which compares core equity capital to risk-weighted assets, has risen at most major banks from 8.45 in 2010 to 9.2 this quarter. Only Bank of America’s Tier 1 ratio has declined to 8.23. Also, while the real estate markets remain soft, the quality of loans banks hold on their balance sheets are improving. Non-performing loans at Wells Fargo have fallen from $27.3 billion to $25 billion while PNC Financial saw its non-performing loans fall from $5.8 billion to $4.4 billion.

Finally, banks are cheap by historical standards as well. Many banks trade at below book value, meaning the bank’s assets divided by number of shares are more than what it costs to buy a share of stock. Yahoo! Finance reports that JPMorgan trades at .75 book value while Bank of America trades at .32, Citi at .43 and Morgan Stanley at .52. To put these figures in perspective, McDonald’s and Microsoft trade for 6.06 and 3.52 times book value respectively. Also, most of these banks trade for less than 10 times earnings, lower than the stock market average of around 16 times earnings, indicating banks are undervalued.