Memo to Banks: You are Toast

The big banks are reporting that profits are up. Citigroup is celebrating a 46% gain in share prices and net income of $1.31 billion. Wells Fargo just reported strong profits.Yet there are many reasons to doubt the good news. As I’ve said before, it is more likely that they are toast.

First, the income reports result in large part from reductions to loan loss reserves. Yes, banks are partying like it is 1999—everything is hunky-dory so there is no reason to sock away reserves against possible defaults. Heck, no one is going to default in 2011. Right? Move those reserves into the profits column.

Banks are not making any money in traditional lines of business—that is, by making loans. No one wants loans. The economy is down for the count. Other than pulling money out of loan loss reserves, banks can only make profits by revaluing assets. The write-downs of trashy mortgages need to be reversed. Banks trade trash with each other at higher prices, recording profits. They sell trash to the government at inflated prices—more on that below. And they jack up late fees on homeowners, credit card users, and other debtors. Even though none of those borrowers can actually pay the late fees, the banks book the revenue now.

But here is the much bigger problem: the banks are getting sued from here to Pluto by homeowners, soldiers and sailors, Fannie and Freddie, PIMCO, the NYFed, and just about anybody with access to a lawyer. And, increasingly, the banks are losing.

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