Watch stocks you care about
The single, easiest way to keep track of all the stocks that matter...
Your own personalized stock watchlist!
It's a 100% FREE Motley Fool service...
Markets exploded today because of a memo from Citigroup (NYSE: C ) CEO Vikram Pandit, telling employees that -- surprise! -- the bank was actually on track to post its best quarter in over a year ... and a profit! Maybe things aren't as bad as we thought! We're saved! We're saved! Whoo-hoo!
Not so fast
You can't blame the market's reaction. Since Feb. 6, the Dow Jones has risen all of five times. Even relatively healthy banks like JPMorgan Chase (NYSE: JPM ) and Wells Fargo (NYSE: WFC ) are being treated like basket cases. Anything that can be slightly spun as good news is bound to be clinged to. Just give us any good news -- even if it's not, you know, true -- and the market will run with it.
This is no exception. Citigroup's announcement that "Hey, hey, we're actually profitable!" is twisted, tortured, and largely irrelevant to its ultimate fate.
The gist of Pandit's memo was that operating profit was going gangbusters -- as if operating profit has been the problem all along. The problem is not a bank's ability to generate current income, but its ability to absorb losses on legacy assets that are worth a fraction of their purchase price -- using absurd amounts of leverage to boot.
The memo disclosed numbers that point to an operating profit of about $8.3 billion this quarter, but Pandit didn't give any mention of what asset writedowns would be. "In January and February alone, our revenues excluding externally disclosed marks were $19 billion," he said. Great! Now... uh... about those "externally disclosed marks?" How are those workin' out for you?
I'm not worried that Citigroup can't generate operating profit: I'm worried it's not solvent. There's a big difference. Imagine a person drowning in debt but insisting they're wealthy because their paycheck exceeded their grocery bills. You get the idea.
Same game, different day
You can't blame bank CEOs for trying to instill confidence these days. Bank of America (NYSE: BAC ) tried a similar approach a few weeks ago, telling investors that Countrywide and Merrill Lynch were the "stars" of 2009, and that Merrill Lynch will be "a thing of beauty," pointing to, you guessed it, operating profits.
It doesn't take a tremendous amount of thought to see that if a company has an operating profit of X and losses on existing assets of X times 100, things might not turn out so hot. Such is the case with Merrill Lynch, whose losses in 2007 and 2008 wiped out all profits earned over the preceding eleven years, and ultimately caused B of A to become the recipient of one of the largest federal bailouts ever. "A thing of beauty" indeed.
Posting the occasional operating profit will indeed provide a cushion for banks to absorb impending writedowns, but it's a clown show to think it'll be enough to plug the black hole of losses, especially in Citigroup's case.
For related Foolishness: