TCS Daily


A Yield-Curve Rally on Wall Street

By Larry Kudlow - March 10, 2009 12:00 AM

The upward-sloped yield curve has come to Wall Street for a real bailout of the big banks.

Today, Citigroup CEO Vikram Pandit told Bloomberg that the bank has turned profitable with its best numbers since 2007. This echoes what BofA CEO Ken Lewis told CNBC about two weeks ago. At the heart of this newfound profitability is a very simple but powerful idea: When short-term Treasury rates are well under long-term rates, banks profit. This is principally because banks borrow short to lend longer.

Back in 2006 and 2007 the yield curve was inverted, and it took its toll on the banking system — playing a major role in the credit crunch. Now, however, Citi, BofA, and probably many others are experiencing good trading profits and good money on their various servicing functions for consumers, corporations, and governments.

Net interest margins are rising. Short-term money is almost free these days, with the fed funds rate near zero and T-bills around 25 basis points. But the rest of the curve is 2 to 3 percent. Additionally, FDIC-guaranteed deposits are surging at all the major banks, providing a strong lending base.

All of this has created a huge 300-point rally in Wall Street trading — led by the financials, but extending across-the-board to all sectors on strong volume.

The banks do have plenty of underwater toxic assets. But there is too much obsessing about these assets, which are held for long-run investment and should not be marked to market as there is no distressed market. Instead, investors should look at positive cash flows — and the strong profitability from these cash flows — in the new interest-rate environment of the upward-sloping Treasury curve.

What's more, the banks are funding their daily positions with no trouble. When Bear and Lehman failed it was because they couldn't finance their daily positions. Obviously the banks are in better shape.

Helping today's trading, Rep. Barney Frank announced that the SEC would be restoring the uptick rule for short sellers, which has been in place for a long time over the past couple of years. This means bear raids on banks will be tougher since traders will have to wait for a stock to go up in price before they short it. But selling shares on a downtick in price greases the skids towards ridiculously low share prices for banks and others (think GE).

There also is a lot of rumbling about a liberalization of the mark-to-market rule, which has wreaked so much havoc on bank profits and capital. One way out is to ask the banks for a market mark, but to amortize the implied losses over a period of five-to-seven years for regulatory capital purposes. This also would buy plenty of time for better bank earnings to bolster bank capital positions.

Whether today's big rally marks a turnaround or just a dead-cat bounce from an oversold market remains to be seen. But surely the return to profitability of America's biggest banks is a good sign for economic recovery.


This article first appeared on Kudlow's Money Politic$.
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2 Comments

Wall street
They used to say that NY was the financial capitol of the world. I just heard some guy on TV saying that now it isn't even the financial capitol of the United States; DC is, with those idiot politicians controllong so much of the economy; Barney Frank, sorbeyns-oxley, etc. Even before we saw a lot of financial action going to freer places like London, Singapore, Shanghai, etc. now we can expect even more. Maybe NY will become a sort of Toronto of the financial world soon.

You know, Larry...
Vikram Pandit is simply attempting to confound the government's process of closing out Citigroup. Stating that his continuing operations are making money is silly. Obviously his lending business is profitable. And his credit card portfolio...with those astoundingly high rates and his astoundingly low cost of capital. Yes he is making money on those elements of his Income Statement that are not losing money.

But his financials will not tell any such story when he must close the books for this Quarter one month from now. Citi will suffer another breathtaking loss. Therefore, he might say whatever puts a positive spin today on the reality of his business...but he cannot avoid the actual numbers. And they will be grim.

Those of us who do business with Citi are very much concerned regarding some of the programs they put in place during the past few weeks...and that we were notified about. They seem to already be deployed an endgame routine...a winding down process. For certain they are not lending at any greater pace. Instead, they've been pulling in credit lines and moving their asset side toward cash. One word for that behavior is liquidation.

They might be preparing to fold the tent in an orderly manner...and if so then they have started to pull up the stakes.

Not to say that Dr. Pandit has lost all hope that he can somehow save the bank...it's his job to try, of course. But Citi is not profitable at this time...and it is very near insolvency.

However, Citi cannot be allowed to fail. It is too big and its liabilities are assets on the books of too many. We learned our lesson about that with Lehman Brothers. However the government does not have the legal mechanism in place to simply take over Citi without letting it fail first and watching it seized by the FDIC. And that can't be allowed to happen.

So the government must continue pumping money in. This move by Pandit was possibly timed to interrupt efforts being made in the Congress to write a law allowing someone like Chairman Bernanke to preempt such a failure and to take over this sort of near-death Balance Sheet intact. To nationalize this bank insofar as we have already more than paid for it.

Of course, then we are Communists...and that creates a different set of challenges.

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