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Big Banks Pile Up Victories — at What Cost?

The sector is scoring on all fronts, except for ensuring future safety


With apologies to the Geto Boys: Damn, it must feel good to be a banker.

Less than five years after they brought the global financial system to a halt, here’s what the scorecard looks like for the nation’s biggest banks:

  • They’ve struck essentially painless settlements over the mortgage and foreclosure fraud scandals.
  • They’ve avoided the worst of stringently higher international capital reserve requirements.
  • They’re enjoying the fruits of a stabilized housing market, with the attendant mortgage and refinancing activity.
  • They’re reporting huge profit gains.
  • And they’re seeing their share prices soar.

Oh, and not a one of the bankers ever went to jail for all the damage they wrought such a short time ago.

The last couple of weeks offered a slew of good news for the biggest banks on the legal, regulatory and earnings fronts. No wonder their stocks continue to put up market-shredding gains.

The last and biggest legal risk investors had to worry about is over and done. It went kaput when 10 of the nation’s biggest mortgage services agreed to pay $8.5 billion to compensate borrowers who were the victims of bad foreclosure practices.

From the perspective of the banks, it’s a pittance of cash well spent. When you consider that JPMorgan Chase (NYSE:JPM) alone took a $6 billion loss on its infamous London Whale trading debacle, well, $8.5 billion split among 10 lenders — including Chase, Bank of America (NYSE:BAC) and Citigroup (NYSE:C) — ain’t gonna, ahem, break any bank.

Indeed, it’s worth every penny to have the legal risk and uncertainty off everyone’s plates.

Longer-term but even more important, at the same time banks were putting the foreclosure scandal behind them, they won a critical victory against tougher new rules.

International regulators have been working toward ensuring that all banks have more than enough capital on their books to prevent any one from going bust and threatening to take down the entire system.

Bankers, of course, don’t like to keep a big capital cushion just lying around, doing nothing. After all, they make profits by lending that money out, or by trading with it — preferably with as much leverage as possible.

So, it was a victory for the banks when the regulators in charge of writing up the international Basel III capital rules blinked and said stocks and high-grade mortgage-backed securities, among other pieces of paper, could be counted as “safe” bank capital.

The problem with this, as you can plainly see, is that unlike actual cash or, say, Treasurys, the value of these assets will fall in any bank panic, making the banks’ capital cushions a foundation built on sand — just like the last time the global financial system ground to a halt.

Bottom line: Banks beat regulators yet again.

To top it all off, bank profits are back and helping lead the market higher. Citigroup, for example, was the biggest disappointment this earnings season, when it missed Wall Street forecasts because of a slew of charges, including setting aside a billion dollars for legal and regulatory assaults.

But net income still rose 25% — 25% — year-over-year.

Have a look at these results before you shed a tear for the banks. JPMorgan Chase saw profits jump 53%. Goldman Sachs’ (NYSE:GS) net earnings nearly tripled. Wells Fargo (NYSE:WFC) earnings jumped 25%. And Morgan Stanley (NYSE:MS) swung to a fourth-quarter profit from a year-ago loss.

True, Bank of America’s profits plunged as it cleaned up its mortgage mess, but results still beat Street estimates.

As we’ve noted before, the money-minting days are over for investment banks like Goldman Sachs and Morgan Stanley, as well as the big money-center banks. But profitability — thanks in no small part to rampant cost-cutting — is very much back.

Financials are forecast to lead all sectors of the S&P 500 with a fourth-quarter earnings growth rate of more than 12%. (The broader market will be lucky to post profit growth of 2%.)

Meanwhile, over the last 52 weeks, shares in the biggest banks are up anywhere from Wells Fargo’s 14% gain to Bank of America’s 57% leap — market-beating performances through and through.

The good news is that it’s pretty much impossible to sustain this current bull market without leadership from the financial sector, so it’s good to see the bank stocks taking off like this.

The bad news is that we never really addressed the shenanigans that caused everything to implode in the first place. The foreclosure fraud scandal is dead and buried, and it turns out that those onerous new capital requirements won’t be nearly so onerous after all.

Enjoy the ride, but don’t be surprised if it all comes tumbling back down again in the not-so-distant future. In case you hadn’t noticed, history has a way of repeating itself on Wall Street.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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