Insights & Advice

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What’s that Light at the end of the Tunnel?

The stock market is up almost 30% in less than six weeks. Recent economic statistics from auto and home sales to consumer spending and housing starts indicate at least tentative signs of improvement. Pundits in increasing numbers are stating that we’ve seen the worst. Even Fed Chief Ben Bernanke is claiming to see a few economic “green shoots” sprouting among the weeds. There is light at the end of the tunnel, they all say, and point to the banks as proof of their argument.

On the surface it sure looks that way. Take Wells Fargo bank that predicted they will make over $3 billion in first quarter profits on the back of a surge mortgage applications this quarter. Goldman Sachs followed suit this week by reporting earnings that were double Wall Street’s estimates. JP Morgan, Bank of America and Citibank let slip that the first two months of the year were profitable for them. Does this mean the credit crisis is over?

Well not exactly. It’s pretty hard not to make a profit when the taxpayer via the federal government is throwing money at you. Banks borrow from the Fed or Treasury for free or next to nothing and then loan that money out to you at much higher rates and pocket the spread. And you don’t need a lot of borrowers to make money under those conditions. At the same time all those nasty toxic assets on their books are no longer being written off as losses thanks to an accounting change of the Financial Accounting Standards Board last month (see my column “Mark to Market”).

Unfortunately, I suspect much of the banks recent posturing has much more to do with two things. The first is the upcoming results of the government’s stress tests which are supposed to gauge the health of the nation’s 19 largest banks. Don’t think for a moment that any of these financial institutions will flunk the test. Expect the U.S. government to release broad data that won’t single out any bank as ‘troubled’ but might point out where banks would face stress “if’ the worst were to happen. And of course the government will be there in any event to rescue said institutions. In my opinion, the whole scheme is simply an exercise in governmental public relations to bolster your confidence in the American banking system by giving its seal of approval to the country’s banking industry.

However, several of the bigger banks are trying to preempt the coming results. By making positive statements about their newly-found financial health, these institutions are attempting to telegraph to investors that they are healthier than the next guy. So as these game progresses expect more in the way of “good news” from the banks.

The second objective of this banker’s shell game is to raise the price of their stocks. After seeing its share price rise from $75.65 to $130 in slightly more than a month, Goldman Sachs then raised $5 billion in a stock offering this week. They announced plans to pay off the bail-out money they received under the TARP program with the proceeds. Citibank will be next and will try to raise billions shortly with the same maneuver. Does all this mean the banks are buys and the crisis is over? Is there truly light at the end of the tunnel?

Well, according to President Obama in a speech on Tuesday at Georgetown University, these are signs of economic progress but he also warned of tough months ahead for the economy. In my opinion, a lasting recovery is going to take much more time. Like it or not, we are a consumer -driven economy and we live or die by spending.
I’ve written many times that the key to spending is confidence. You and I will spend if we feel confident. Confidence is largely based on trust. How has these recent shenanigans by Goldman, Wells Fargo or Citibank rebuilt my trust in the banking system? Sure the stock market is up but do you feel confident that your job is secure, that you will be getting a raise anytime soon? How confident are you that you can pay down your debt load over the next six months?

“No way, Jose,” said a friend who works for one of the top telecomm providers in Pittsfield, MA., “I’m using every cent I can to pay down debt.”

The same sentiment was echoed this week by people I talked to all over the nation. Yet there are sings of improvement. Two families here in the Berkshires I know have taken advantage of the low rates to refinance their mortgages while a third just purchased his first home in Cheshire. The money saved on refinancing however is going to make ends meet and for savings, not additional spending.

The point is that it’s going to take more than a few earnings announcements or a stock market bounce for most Americans to begin to spend again. The restoration of confidence, the paying down of debt, the bottoming out of housing prices and finally increased spending will come but it’s going to take more time than most people think. Hopefully, the market won’t get ahead of itself because right now most consumers are still afraid that the light at the end of the tunnel may simply be another on-coming train.

Posted in A Few Dollars More, Macroeconomics