By Sean Vidolin, Rutgers University
As the financial markets have begun to approach the pre-Lehman levels of 2008, it has come into constant question amongst analysts over whether or not the huge run up we've experienced since last March is sustainable or not. In a rally that saw the S&P 500 rally from the high 600's in March of 2009 to just over 1200 in the past couple days, it is heavily disputed whether or not a rally of this magnitude is truly representative of the state of the banking industry. Recent earnings from JPMorgan suggest that this rally was deserved, as they posted a better than expected 55% rise in their bottom line.
This past Thursday, Bank of America reported a decline in loan losses for the month of March to 12.54% from 13.51% in February. The charge off rate is the percentage of loans that a company has determined as not being repaid, usually after six months of nonpayment. Despite the monthly decrease, this percentage is still significantly higher than the pre crisis numbers. Loan losses over the past few years have been a huge problem for banks, who have seen reduced earnings as high unemployment has forced write downs for loans issued that can no longer be repaid by the debtors. Despite the Obama administrations attempts at bolstering loan modification programs to prevent foreclosures, there is still large concern over whether or not we will see a double dip in housing prices. The data accumulated from the housing market over the past few months of recovery has been far too inconsistent to determine whether or not the market is significantly improving. Without a better housing market, banks will continue having to write off bad loans and will struggle to rebuild the core of their businesses.
What's troubling about JPMorgan's numbers was not the top or bottom line numbers, which both outperformed even the highest of analysts' estimates, but the underlying skepticism in these core operations numbers like loan losses. Boasting huge profits from proprietary trading may be impressive, but it's sustainability comes into question as the Obama administration continues to impose stricter regulations on banks' trading practices. Additionally, while JPMorgan posts huge profits from trading, we need to understand that they have some of the best traders in the world under their employment; other banks may not be able to duplicate these numbers.
Relying so heavily on trading to bolster profits, these impressive numbers may be short lived as the current administration begins restricting the trading of such high risk derivatives like the collateralized debt obligations (CDOs) and credit default swaps (CDS) that have allowed banks to profit so much in their operations. This past Friday, the Securities Exchange Commission (SEC) announced a lawsuit against Goldman Sachs and one of its top executives for misleading the public into buying poorly assembled CDOs that the firm itself was betting against. Goldman has been accused of working in tandem with acclaimed hedge fund owner John Paulson in manipulating the construction of CDOs littered with bad home loans that they pawned off on investors as they took opposite positions betting against them. As Paulson's hedge fund pulled in over $15 billion in profits, individual investor losses amounted to over a billion dollars after being misled by their brokers into believing they were making strong investments.
As the next few weeks in earnings approach, don't be surprised to see better than expected numbers from the banks. But take a closer look at what the profits are stemming from. If it's trading, you may have reasons to remain skeptical of the magnificent gains in stock prices over the past year. Maybe these profits are sustainable, maybe they are not. What we can be sure of, however, is that a full recovery requires more than profitable trading. It is not until the housing market improves, unemployment falls back to it's normal levels, and loan losses start consistently falling that we will see a strong, reliable return to profitability in the industry.
