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The Bailed-Out Banks Are Looking Shaky at Best, But Their CEOs Are Well-Insulated from Collapse

No upward limit is in sight for financier compensation, with CEO salaries now at about a million a year. But the banking institutions themselves are in for some bumpy days ahead.

Since the catastrophic bank collapses of 2008 and the government rescue of the finance industry, Wall Street has staged a dramatic comeback. Since the bailout, profits are up, capital reserves are up, stock prices are up, government direct aid has been paid back, and executive compensation is exploding. But a closer look shows bank stability is just skin-deep, and dense accounting rules hide a powder keg of bad debt and mounting funding issues. While the recent paper-thin re-regulation of finance was a major political victory, the banks’ core business is headed downhill and even worse trouble seems to lie ahead.

All of the big four U.S. megabanks -- Bank of America, Citigroup, Chase, and Wells Fargo -- reported either decreases or very modest increases in their massive profitability during 2010. But this surprisingly weak performance would have been even more disappointing without a pair of accounting maneuvers. One was a bookkeeping measure allowing banks to book projected profit from buying back their debt when their bonds become cheaper. But the banks rarely buy back their debt, so this is essentially a paper gain. The other penstroke that boosted profit was consumption of money set aside to protect against losses on loans -- as banks have grown more outwardly confident about the economic recovery, they have lowered their stated expectations of bad loans and designated some of their capital cushions as profit.

But these shallow techniques for elevating profit weren’t enough to compensate for the decline in banks’ core business -- interest income, the money collected from loans minus that paid out to depositors. That income has consistently dropped this year, mainly due to falling loan volume. Banks are making fewer loans to consumers and businesses, citing a “lack of demand,” which obscures the quite favorable credit rating now required to get a loan. The lower supply of qualified applicants as job losses persist, combined with locking out applicants with spottier credit history and a general consumer preference to reduce total debt, have all caused bank loan books to continue to shrink in the feeble recovery.

The market has not rewarded the banks for the elaborate camouflage of this core weakness, and their stock prices have lately sagged as a result. But executive compensation is another story, and traders’ pay is also rebounding into the $200,000-to-$500,000 range, while tens of millions of Americans struggle to keep food on the table. Meanwhile Obama’s much-hailed “pay czar” in charge of monitoring finance executive compensation, Kenneth Feinberg, has reported that within three months of receiving their bailouts, the megabanks had paid out $1.6 billion in bonuses -- up to a quarter of their TARP rescue totals. However, the “czar” has no formal power to rescind exorbitant pay now that the majors have repaid their government capital infusions, and compensation will now be monitored by a rather un-intimidating consortium of regulators. With the CEOs of the banking majors making about a million a year each in straight salary, no upward limit is in sight for financier compensation. But the banking institutions themselves may have some bumpy days ahead.

Extend and Pretend and Descend

While the banking majors were relieved of much of their bad home mortgage-based investments by government purchases in the course of the financial crisis and aftermath, large loans related to commercial real estate remained on their books. Many of these loans were to growing businesses and overoptimistic developers, and have frequently failed to perform, as the recession has rendered projects unprofitable, reducing borrowers’ ability to repay.

But the loans are often for sobering amounts, upwards of tens of millions of dollars, and rather than foreclose on such large credit lines, banks large and small are engaging in what has come to be called “extend and pretend.” The practice involves not taking legal measures on underperforming commercial real-estate loans, but rather “restructuring” loans with new, more favorable terms for the borrowers, like below-market interest rates or extended timelines for repayment. The goal of the practice is to prevent foreclosure on large loans, with the hope that extending maturities will give borrowers enough time to recover their business and repay.

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