Bank Profits Somehow Increasing Even Though Economy Worsening

So here's an interesting question: how are bank profits increasing when the economy and many of the loans written by the banks are in worse shape then ever? Don't believe the numbers.

So here's an interesting question: how are bank profits increasing when the economy and many of the loans written by the banks are in worse shape then ever?  Don't believe the numbers. AI close look at those bank profits show that most of them weren't from better performance, but rather from the same type of financial manipulation that got the banks into a bad situation in the first place.

First, many of the banks benefited from the recent change in accounting rules that relax mark-to-market accounting.  I wrote in an article last week about the FASB mark to market accounting change:

"The bottom line is this.  Banks, which have shown they are incapable of pricing assets and managing risks are now going to have more latitude in pricing the crap they hold on their balance sheets.  I say stay away.  It's clear it's just another tactic by the financial powers that be to preserve their own companies and wealth at the expense of shareholders and the tax paying public."

Now, two weeks later, lo and behold, the banks have better than expected earnings.  One would be wise to question those earnings.  The economy and loan delinquincies have not improved.  Foreclosures continue to surge and now credit card, commertical loans, student loans, and other types of debt are showing ominous default rates.  The only thing that could positively impact the banks would be the super low, taxpayer subsidized liquidity.  Bank can borrow money at 0% and lend it out at 4-5%, a recipe for profits - if they were lending.

In the case of Bank of America, Ken Lewis even has an incentive to juice earnings for the quarter - his job is on the line.  He's fighting for his job amidst what is expected to be a close proxy vote on whether he should remain as Chairman and Chief Executive Officer.  My answer: look at the stock's performance over the last ten years and see if he and his management team have maximized shareholder value.

As Andrew Sorkin wrote in the NY Times Dealbook Blog:

Bank of America sold its shares in China Construction Bank to book a big one-time profit, but Ken Lewis heralded the results as “a testament to the value and breadth of the franchise.”

Sydney Finkelstein, the Steven Roth professor of management at the Tuck School of Business at Dartmouth College, also pointed out that Bank of America booked a $2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired last quarter to prices that were higher than Merrill kept them.

“Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty,” he said.

Yesterday, the markets saw through these financial shanigans and punished bank stocks, driving Bank of America down more than 20%.  You'd think the "financial titans" would have learned that the jig is up.  I guess not yet.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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Comments

  • Anonymous

    April 23, 2009

    Banks just don't get it! Trust is being lost on a daily basis. If they keep it up there stocks will be below $5 again.

    Great article!

  • cashcow

    April 23, 2009

    Banks just don't get it! Trust is being lost on a daily basis. If they keep it up there stocks will be below $5 again.

    Great article!

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