Banks' Earnings Indicate A Return To Old Tricks

It's official: the financial sector is back on the road to where it was headed before the credit crisis began. That is the message to be gleaned from last week's stellar earnings reports for Citigroup, JPMorgan, and Goldman Sachs.

While Goldman Sachs and JPMorgan reported huge second quarter profits from trading and investment banking activities respectively, Citigroup managed to surmount its money-losing operations with profits from a windfall income in the sale of its Smith Barney unit to Morgan Stanley.

To a euphoric business press corps and to Washington lawmakers, the earnings represent the first genuine signs of green shoots in the financial services sector.

But on closer inspection, these profits reveal little more than the return of risk appetite in the face of rising problems at the operating-level. For instance, in the case of JPMorgan, investment banking revenue helped offset rising defaults on consumer loans, while Citi masked its operating losses with a one-time asset sale.

That doesn't mean to say that the banks won't continue to perform well in subsequent quarters over the next year, or that there won't be any further increase in risk appetite to help reinstate the old game of piling more money on top of shaky financial foundations.

But it does mean that at some point, the sector will have to get into the business of producing tangible products that benefit the consumer and the economy as a whole, while decreasing its reliance on windfall trading gains (which are highly volatile at the best of times) and asset securitization. This is similar to the point I made here at BNET Finance last week about how Goldman Sachs must now focus on investing in its fee-earnings operations in order to ensure a stable future.

In other words, just because there's more money swirling around than there was at the beginning of the year, that doesn't mean that the U.S. banking system is any more secure than it was back then.

If banks cannot unwind their dependence on short-term tricks to fatten their wallets, another round of deleveraging will eventually come knocking at the door. That's as much a mathematical certainty as it was the first time financial firms pinned their growth on such conduits.