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Why This Week Is The Year's Best One For Banks

This week is shaping up to be one of the most significant this year for the long-term outlook of the banking industry -- and the news is way more positive than anyone could have hoped.

Previously, the biggest fear was that another round of deleveraging, possibly initiated by the lack of funding available to the beleaguered regional banking sector, would strike at the heart of financial services firms. That would have meant that the only solution was to initiate a second government stimulus plan.

But two pieces of news -- one good, and one not so good -- imply that the worst-case scenario is unlikely to happen.

First, the ugly news. CIT Group, a lender to small and medium-sized businesses has announced that, after a crisis of liquidity last week, it is now in talks with regulators about a possible rescue plan. With talks also in the pipeline about a stimulus for regional U.S. banks, Washington is finally getting the message: save the little guy, and you're building from the bottom up. That's what may keep unemployment from rising into double-digits, and it's also what will keep lenders lending freely.

Just as the subprime crisis began from the very bottom of the credit line, so the banking system it wreaked havoc on needs building from the same place. The importance of how exogenous shocks such as CIT's woes are dealt with cannot be understated: one blast from out of nowhere could easily create an industry-wide meltdown.

The second piece of good news comes from the very largest, most liquid and creditworthy institution in the country. When Goldman Sachs announced its impressive second-quarter earnings results this morning, it signaled a bright light at the end of the subprime-slimed tunnel.

Specifically, if Goldman Sachs had underperformed expectations, it would hardly have inspired much confidence among those who claimed that it was still too premature to allow the repayment of TARP funds, such as the Congressional Oversight Committee. In other words, a Goldman Sachs earnings miss would have created an endogenous shock to the financial system, and to the stock market which is crucially beginning to look more and more liquid.

In short, the lack of shocks to the financial services industry which everyone was bracing for this summer, have failed to come about. If everything is handled correctly from here on, the second half of 2009 should look very pretty indeed for the investment banking industry.