In this recent Press Release from the FDIC, Director Sheila Bair pointedly touts the banking industry's strong profitability in the first quarter of 2011. She then goes on to explain the reason banks were showing those profits.
Bair reported that bank profits for the quarter were $29 billion, or $11.6 billion over the same period a year earlier. Sounds pretty strong, right? Here is Bair's explanation for the spike in profitability.
"The industry shows continuing signs of improvement, though there is a limit to how far reductions in loan-loss provisions can boost industry earnings."
How did they do it? A reduction in their loan-loss requirements - that is the amount of money banks set aside to cover bad loans - from $51.6 billion in the first quarter of 2010 to just $20.7 billion - a decrease of $30.9 billion. This decrease in loan-loss provisions returns banks to pre-2008 levels. Is anybody honestly naive enough to believe loan defaults are back at 2007 levels?
ALL of the industry's first quarter 2011 profitability is directly attributable to this reduction in loan-loss provisions. In fact, absent this balance sheet gimic, the industry would have lost almost $2 billion for the quarter - compared to a $17.4 billion profit a year ago. Actual revenue fell by 3.2%. This marks just the second time in 27 years that bank revenues have seen a decrease.
What's worse, each of those banks now face increased risk, with less than half the reserve to cover those losses. As defaults pick up again, banks will have significantly less in reserve to cover those losses, creating an even greater rate of bank failure and... you guessed it - more bailouts.
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