If you want to see the future of banks, take a look at how Morgan Stanley did this past quarter. Last week some of America’s biggest banks trotted out short-term profits that hid deeper and longer-term problems. For the most part, they did better than expected. A few even made money. Some people will take solace in that. Since the banks got us into this mess, they want them to get us out. I think that’s asking far too much of banks. Banks have their hands full just trying to save themselves. Saving the economy would be asking too much.

The rule of thumb is, as the economy goes, so goes the banks. Can the banks even save themselves while households absorb the $15 trillion hit they’ve taken to their net worth?

Morgan Stanley gives us some clues. And we’d be foolish to ignore them. It did the worst of the six big banks which reported last week. So what was its main fix?  It’s replacing the head of its trading desk with a top hedge fund performer. This desk trades bonds, currencies and equities (sort of like what hedge funds do). Morgan Stanley’s trade desk didn’t do very well, especially in comparison to the smart guys at Goldman Sachs…

Goldman Sachs lost more than $100 million on six trading days over the quarter and earned more than $100 million on 23 days. Morgan Stanley lost more than $125 million on four days (including losing $390 million in one day in August) and made more than $125 million on eight days.

Goldman Sach’s ratio of big winning days over big losing days was 3.8. Morgan Stanley’s was two. Morgan Stanley says they’re going to start to take on more risk. Hey, guys, great idea. But you need to get better doing your trades first.

This is how banks are now making profits … not from loans but from risking taxpayer-paid TARP money, guaranteed Fed-backed loans and money from depositors and risking it on trades where you can make over $100 million in a single day but also lose $100 million (or in Morgan Stanley’s case $390 million) in a single day.

If you’re good at this sort of thing, like Goldman Sachs and JP Morgan are, then you can ignore your poorly performing portfolio of loans and tell shareholders that banking is still a good business even though it’s not exactly true. If you’re not that good, then like Morgan Stanley you can talk lamely about taking on more risk.

Before banks leveraged up and paid less attention to asset quality, banking used to be a good business. Borrowing low and lending high was a sure-fire way to generate profits. You can’t get more simple than that. But that wasn’t good enough for bankers. They lobbied for and got the repeal of the Glass-Steagall in 1999. Glass-Steagall had separated deposit banks from investment banks. After 1999, banks could take the tens of billions of dollars from depositors and invest it in anything and everything, from low-yield but safe Treasuries to risky but high-yield derivatives.

As you know by now, not enough went into safe Treasuries and too much went into risky derivatives. A few bubbles later banks were forced to write down about $1.6 trillion on their investments.

The one thing banks couldn’t talk about last week is improving loan portfolios. American Express hinted that their consumer loans may start to default at slower rates in the second half of the year. But Capital One and every other bank refrained from making such bold claims.

Consumers are in debt rehab. It’s hard to overestimate how bad it’s getting for consumers right now. But it’s going to take a while. They’re still spending much more than they make. In the first quarter they borrowed 128 percent of their income.

There’s absolutely no way that banks can separate themselves from this consumer squeeze. And I don’t see accelerating foreclosures and credit card default reversing this year or next…

•    Foreclosures will go up as long as the economy keeps shedding jobs. Whether the economy loses jobs at rate of 450,000 a month or 300,000 a month doesn’t matter.

•    Credit card defaults won’t improve either. People without jobs run up more card debt than people with jobs. And they have less money to pay back what they owe. And even though refinancing is up, homeowners have already cashed out most of the equity in their houses.

•    In Fed Chief Bernanke own inimitable words, “The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook.”

The Obamarons want banks to lend more so consumers can spend more so the economy can get better. Somebody should write them a memo and point out that consumers aren’t looking for loans and banks shouldn’t be forced to lend to cash-squeezed consumers (isn’t that how we got into this mess in the first place?).

But the real scary ticking time bomb is in banks’ commercial real estate loans. Most commercial real estate loans are balloon loans. Companies only have to pay the interest until the full amount is due. And the expiration dates for many of these loans are now coming due.

There’s a cynical saying in Russia which made the rounds during the good ol’ years of communist rule. It went like this: You pretend to pay me and I’ll pretend to work. Russians barely worked and they barely got paid. You could say the same thing about banks and their corporate customers. Banks pretend that the real estate loans to customers are still good, and these customers pretend that they will pay them back. It’s playing out right now, in broad daylight…

Florida-based resort developer Bluegreen Corp. just got an extension on $130 million worth of loans.  Toys R Us, Tanger Factory Outlets and Washington Real Estate Investment Trust also all recently got loan extensions.

How far has commercial real estate fallen? Even Morgan Stanley’s highly regarded Crescent portfolio of properties has taken a big hit. I had been following Crescent for about five years. Before Morgan Stanley bought them out a couple of years ago, Crescent was a Texas-based real estate company. It owned some of the most prestigious office buildings and hotels in Houston and Dallas. Two years ago, its rents were high and vacancies low. Now, Morgan Stanley’s $2 billion exposure to Crescent’s portfolio is seen as a big albatross as tenants look for lower rents in the cheaper side of town.

The $6.7 trillion commercial property market is slipping fast. Prices have fallen about 35% since the market peaked. Morgan Stanley’s chief financial officer said he did not see the light “at the end of the commercial real estate tunnel yet. Peak to trough, you have already had a pretty nasty correction in the market but it is still not looking very good at the moment.”

It doesn’t look good for banks when it comes to their consumer or commercial borrowers. Sure, some of these big banks made loads of money from their inhouse hedge funds. But that stuff can turn on a dime. Last quarter is already ancient history. Next quarter may be entirely different. And next year who knows. Banks are crossing their fingers and hoping for the best. But the economy isn’t cooperating. Banks are playing a dangerous game. They’re walking a tightrope in a stiff breeze, hoping they won’t fall off.  And I think that breeze is going to get a lot stronger over the 12 months. The banks aren’t through falling yet.

To your investing success,
Andrew

Monday
Economic Report: New Home Sales

The New Home Sales report for June comes out this morning. Expectations are for a slight increase versus May. While I am still skeptical of a sustained housing recovery, I do think this report will meet expectations. This is partially based on it being the summer selling season, as well as the fact that existing home sales for June also increased.

Earnings Announcements: Honeywell (HON), Verizon (VZ), Amgen (AMGN)

Tuesday
Economic Report: Consumer Confidence, S&P/Case-Shiller Home Price Index

The July Consumer Confidence report is anticipated to show a slight improvement since last month. With the economy showing slightly encouraging signs of a recovery, job losses slowing, and no spike in gas prices, I think this report will meet expectations.

The S&P/Case-Shiller Home Price Index comes out Tuesday as well, and this report will still show a significant decline, but a smaller decline than in the past.

Wednesday
Economic Report: Durable Orders, Fed Beige Book

Durable Orders for June are expected to show another decline, and I don’t see anything convincing me that I should expect otherwise.

The Fed Beige Book comes out on Wednesday, and everyone will be looking at the book to see if there are any signs anywhere of a recovery. If I had to guess, manufacturing will show a slight increase, real estate in some pockets will show improvement while others areas, like New York City, will be getting worse.

Earnings Announcement: Time Warner (TWX), Visa (V)

Thursday
Earnings Announcement: ColgatePalmolive (CL), Exxon Mobil (XOM), Mastercard (MA), Sony (SNE), Dow Chemical (DOW), Disney (DIS)

Friday
Economic Reports: GDP - Advanced

The Advanced GDP report is likely to show another decline in the second quarter. Until consumers can feel comfortable spending money, GDP is going to continue to fall.

Earnings Announcement: Chevron (CVX)

Respectfully,

Christian Hill

The mobile phone industry has been one of the greatest growth stories of the last decade. Just 10 years ago, very few people carried a cell phone. Today, there are very few people without one.

According to Gartner, the world’s leading information technology research firm, there were 1.22 billion mobile phone sales to end users last year. That’s a 6% increase over the 1.15 billion sold the year before – right in the midst of a worldwide recession. Read the full story

Monday
Earnings Announcements: Haliburton (HAL), Texas Instruments (TXN)

Tuesday
Earnings Announcements: Caterpillar (CAT), Coca Cola (KO), Merck (MRK), Apple (AAPL), Yahoo (YHOO)

Wednesday
Earnings Announcement: Altria (MO), Boeing (BA), Eli Lilly (LLY), Morgan Stanley (MS), Pepsi (PEP), Pfizer (PFE), Whirlpool (WHR), EBay (EBAY)

Thursday
Economic Report: Existing Home Sales

The Existing Home Sales report for June is expected to show another strong month of sales. As I have mentioned in this space before, falling home prices and a glut of foreclosures are increasing sales, but average prices continue to fall.

Earnings Announcement: 3M (MMM), AT&T (T), Ford (F), McDonalds (MCD), Philip Morris (PM), Bristol Myers Squibb (BMY), Amazon (AMZN), Microsoft (MSFT)

Friday
Economic Reports: Michigan Sentiment

The revised Michigan Sentiment report is not expected to change since the preliminary report. I expect the report to show a slight increase. The market hasn’t been doing as bad lately, and job losses have eased a bit. This should cause a very slight improvement in the reading.

Respectfully,

Christian Hill

Resource companies aren’t the only ones hoping for a strong recovery in China. One American franchiser gets about 25 percent of its growth from China. And in three years its profits from China are expected to match those from the U.S. It has a lot at stake in China. Read the full story

Earnings season is just starting to heat up and hundreds of companies will release their quarterly earnings results over the next few weeks.  Read the full story

There is quite a bit of discussion right now about if this market rally is real, and if it is how long it can last.

The last round of corporate earnings weren’t as bad as many expected, and there seems to be some tempered optimism that this could be a sustained rally. Read the full story

Monday:

Earnings Announcements: BIDU, QCOM

Tuesday:

Economic Reports: Consumer Confidence, S&P/CaseShiller Home Price Index

Consumer Confidence is expected to show an improvement in April, although by a less than impressive amount. The reading is supposed to show an uptick of 2.8 percent, however an increase of 5 percent or more is considered ‘significant’. At this point, I think the economy will take any positive move it can get, small or not. Read the full story