- The Washington Times - Sunday, March 15, 2009

Some rare good news from banks last week spurred hopes that the battered financial sector may be starting to heal.

Citigroup and Bank of America helped spawn powerful stock rallies by asserting that so far this year they are running operating profits, although the banks did not disclose what are likely to be big losses on loans in the first quarter that could largely offset those profits.

The banks themselves and most analysts credit the government’s extensive rescue efforts for helping keep the ailing giants afloat since last fall. Those include more than $200 billion in cash investments by the Treasury, massive cash infusions into bank funding markets by the Federal Reserve along with record low interest rates on loans to banks, and government guarantees on the banks’ debts and some loan assets, among other unprecedented rescue efforts.

But analysts say the big banks are not out of the woods yet, as they still have not disposed of the huge toxic loan portfolios that originally caused their troubles, while the deepening recession is worsening their problems with souring loans to consumers, real estate firms and businesses. And since the large banks have lent extensively overseas, another serious threat looms if a full-scale debt crisis breaks out in Eastern Europe or elsewhere.

“The bear took a long overdue respite, allowing the market to stage a modest rebound” last week, said Ashish Shah, analyst at Barclays Capital.

Several developments aided banks, in particular a move by legislators and regulators to speed adjustments in accounting rules that have forced banks to deeply devalue their loan assets. But the markets also benefited from a lessening of fears that the big banks eventually will be taken over and nationalized by the government, Mr. Shah said.

Top executives at both Citigroup and Bank of America declared their intent to avoid nationalization by not asking for any more capital funds from the Treasury - a move that would increase the government’s ownership of the companies. Beyond that, Mr. Shah said, investors seem more comfortable with assurances from the Obama Treasury Department that it does not want to take over the banks.

“The clearly articulated administration plan is to provide support to a private-sector-owned financial system,” he said. And as long as investors aren’t too worried about being wiped out by the government, they see the banks’ greatly depressed stock and bond prices as extremely attractive, he said.

Still, “even though the tone is clearly better, the financial sector remains a dark cloud hanging over the broader market,” he said, and the markets will continue to react to any changes or perceived changes in the government’s policies toward the banks.

Bank stocks got a lift in part because of a push by Federal Reserve Chairman Ben S. Bernanke and House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, to ease accounting rules that have forced banks to value their loan portfolios at today’s depressed market prices. Critics charge those rules have driven some banks to the point of near-insolvency and forced them to seek government aid.

Mr. Frank’s committee extracted a promise from accounting regulators to ease those rules within three weeks - earning plaudits from many banks and investors.

Mr. Bernanke said the rules need to be changed so they do not punish banks when asset prices fall steeply during market busts, as they are now, and at the same time should temper the high values of assets that come with market booms, which led banks in the past to lend promiscuously.

Bob McTeer, former president of the Federal Reserve Bank of Dallas, said that suspending the rules would have an immediate and buoying effect on financial markets and banks.

“It is the only low-hanging fruit that hasn’t been tried” to stem the banking crisis, he said. He contended that if a foreign power had destroyed a fraction of the wealth that mark-to-market accounting has in the past year, “we’d go to war.”

Most analysts do not expect a wholesale suspension of the rules, however. And accounting purists insist that even small changes would only be cosmetic and would not cure the underlying problems at banks.

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