The market is learning. We have finally found a reasonable trading range for major bank stocks that reflects the miserable reality of their circumstances, but removes the blind panic factor. After reporting EPS an order of magnitude greater than the Street consensus, B of A (NYSE:BAC) is still down about 8% in pre-market trading from Friday’s close. Citigroup (NYSE:C) is down about the same. Two issues weigh on bank earnings: an economic slump that will not end, and the government’s penchant for tinkering arbitrarily with the system, as in the case of loan modification, as I noted last week. The Obama administration has opened a Pandora’s Box with loan mod that makes recovery values and timing unclear for subprime mortgage bonds.
Left to their own devices, academics like Larry Summers would go off the deep end, much like the scientists (in Gulliver’s Travels) who live on the floating island of Laputa. As Rahm Emanuel said, liberal tinkerers never want to let a good crisis go to waste. The scientists go about with their noses in the air, and would fall off the edge were it not for small boys armed with inflated balloons attached to sticks. When the scientists get too close to the edge, the small boys bop them on the nose so that they retreat.
That’s a reasonable description of US government policy towards the banks. PPIP was a stupid idea, as JP Morgan’s (NYSE:JPM) Jamie Dimon said last week. The stress tests are “asinine,” as Wells Fargo’s (NYSE:WFC) Kovacevich observed. Nationalization AFTER the US government got on the hook for $9 trillion of loans, capital injections, and contingent liabilities might have brought down the credit of the United States itself. The administration thinks that stabilizing the banks will bring about an economic recovery. I believe no such thing. Bank lending is a lagging indicator. What leads recoveries is entrepreneurial risk-taking.
The banks can eke out a living cannibalizing toxic assets, trading fixed income, earning outsized fees from mortgages (which people will pay because underlying rates are so low). They will chalk up increasingly-worse credit losses, meanwhile. Sometimes they will be on top of the log as they go downstream, and sometimes the log will be on top of them. But their earnings power will be weak and uncertain and their stock will languish around present levels indefinitely. The bank stock story is about to get very, very boring.