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Smoke and Mirrors Won't Help Bank of America, Wall Street

Corporate earnings always involve a fair amount of theater, but you sense reality tearing at the seams in viewing the latest Wall Street productions. Earlier this week, we had JPMorgan Chase (JPM) and Citigroup (C) shuffling loan reserves around to juice "profits." Goldman Sachs CEO Lloyd Blankfein touts the investment bank's "solid performances across our businesses," even as its sales and earnings plunge.

Today, Bank of America (BAC) reports a net loss of $7.3 billion while asserting that its balance sheet is "strengthening." Even that figure is questionable. The company blamed the decline not on, say, its falling consumer and commercial lending or stagnant investment banking business, but on a part of the Dodd-Frank financial reform law that caps debit-card interchange fees. Thing is, the Federal Reserve has yet to set the "swipes" rates (and won't until next year), meaning that B of A is only estimating the impact of the new rule.

Indeed, since the financial crisis, taking the Street's earnings at face value has required a huge suspension of disbelief. The feds camouflaged the companies' real financial condition in three ways: conducting bogus "stress tests" on the nation's biggest banks; injecting billions of dollars through TARP; and suspending mark-to-market accounting, which allowed banks to forestall losses.

Allowing banks to mark up loans that should've been marked down allowed the companies to set aside less money against future losses on those assets. In effect, banks were able to feign a return to health, which in turn helped them raise capital in the private market. As hedge fund investor John Hussman explains in analyzing the banks' performance since 2009 (h/t Credit Writedowns):

Over the following quarters, banks substantially wrote up their assets, and they issued a large volume of additional stock. The new issuance created a moderate but legitimate improvement in the financial position of these banks, but the asset writeups appear to be inconsistent with the growing volume of delinquent and unforeclosed homes, and the deteriorating debt-service performance of commercial mortgage-backed securities. Presently, the U.S. financial sector is essentially opacity masquerading as solvency.
Truth is, the outlook for big banks remains nearly as dicey today as it did in 2009. Although the credit environment is improving, that won't wash away the billions of dollars in bad loans dirtying their books. It also doesn't offset banks' rising costs as a result of dealing with delinquent borrowers or ease long-term problems in the housing market. Even low interest rates are working against the companies by lowering their investment returns.

B of A's prospects are dim over the next year not because of falling fee income (although that's not helping), but mostly because the economy is cooling at a time the company is trying to climb out of a deep, dark hole:

In short, Bank of America has plenty of capital, but is still struggling to find ways to use it profitably while combating economic and regulatory headwinds. The bank said it will start testing "new offerings" for consumers in December and other "new products" early next year. But it's unclear whether consumers want or need any of those offerings or how much new revenue they will deliver.
Also clouding B of A's future, of course, are the possible legal and financial repercussions from the "robo-signing" scandal. Those remain uncertain, although the company has sought to restore confidence in its foreclosure procedures by saying it will resume foreclosures in 23 states. That puts B of A, and any other bank that follows suit, on a collision course with state legal officials investigating the matter. Any move by the states to halt foreclosures will further dent bank earnings. There's no concealing that, either.