Bank stocks carry Wall Street to another gain

Citigroup, its stock trading under $1 just a week ago, cleared $1.50. Other bank stocks rallied, too. The CEO of JPMorgan Chase said his bank, like Citi, made a profit for January and February.

Wall Street, which managed to avoid losing ground immediately after a big rally for the first time all year, held its breath. Were the banks actually showing the beginnings of a turnaround?

No one was saying the financial crisis was over. But stock in Citigroup, JPMorgan Chase and Wells Fargo all advanced again one day after Citigroup's CEO surprised investors by saying the bank ran at a profit in January and February.

It was enough to carry the Dow Jones industrial average to a paltry but nonetheless significant gain of nearly 4 points - the first time since early February the average has strung together two days of gains.

Wall Street hopes a blitz of government efforts to repair the financial system may be starting to pay off - and it's fixes behind the scenes, not the headline-grabbing infusions of billions of dollars, that appear to be doing the trick.

For months now, the Federal Reserve and Treasury Department have been guaranteeing and buying corporate debt, paying interest on the cash banks have in reserve and purchasing mortgage-backed securities.

The first sign that those efforts are starting to work may have come when Citi CEO Vikram Pandit said in a letter to employees that the bank expects to post a quarterly operating profit for the first time since 2007.

Why? Because banks don't just loan out money - they borrow it themselves, too. And when they can borrow more cheaply, as the government rescue moves have helped them do, the bottom line looks a lot better.

"Cash flow will build up, like a river builds up in flood time," said Roy Smith, a professor of finance at the Stern School of Business at New York University, who said he thinks the banks could be on the road to recovery, barring any more market panics.

The good news from Citi fueled a 379-point gain for the Dow Jones industrials on Tuesday, by far the biggest market rally of the year. The average gained 3.91 on Wednesday - not much, but good for the Dow's first two-day win streak in five weeks.

Citi was shaky enough that the government had to take a 36 percent stake and pump $45 billion into its coffers. But at the very least, the announcement appeared to relieve fears that Citigroup is in imminent danger of becoming insolvent.

"I am most encouraged with the strength of our business so far in 2009," Pandit wrote.

Wall Street was especially heartened that the news came from Citigroup, a bank that had lost money for 15 months and had appeared so unstable that one senator, Republican Richard Shelby of Alabama, labeled it a "problem child."

"It's a positive that the bank in the worst shape out there is able to post a profit for a couple months," said Keith Davis, a bank analyst at the money management firm Farr, Miller & Washington. "People are seeing a little bit of light at the end of the tunnel."

But there are signs of hope beyond Citi. JPMorgan Chase reiterated Wednesday that it, too, operated at a profit in January and February. Wells Fargo has said its results for the two months were "strong."

The banking sector posted a second straight day of gains Wednesday on Wall Street. Citigroup stock, which traded below $1 last week, finished at $1.54. Bank of America gained 3 percent, JPMorgan more than 4 percent and Morgan Stanley 8 percent.

Smith says the Citigroup's profitability should be no surprise after all the steps the government has taken to bring down the bank's cost of borrowing money.

Governments around the world slashed interest rates late last year, encouraging banks to lend to each other at lower rates. When governments started buying and backing short-term corporate debt, it freed the banks to lend more money and allowed banks to borrow at more reasonable rates.

One closely watched measure of what it costs banks to borrow money, an rate known as Libor, stands at 1.3 percent now - down from 4.8 percent in October, when fear threatened to choke off lending throughout the financial system.

At the same time, banks like Citigroup are keeping interest rates on other loans high - notably on credit cards. Interest rates for the most popular cards have risen for three straight weeks, according to Bankrate.com. The average annual percentage rate has even gone up for customers with strong credit.

"The cost of funds to the bank has been very low, and they use it to make credit card and other high interest rate loans," Smith explained. "And rates on those credit card-type loans haven't come down."

The banks might be on better footing than they were last fall, but they are certainly far from healthy. A giant unanswered question still looms - what to do about the bad assets on banks' books that started the whole mess.

Those assets could force the banks to record big, potentially debilitating losses. And there is still no detailed plan from the federal government on how to cleanse the banks of them.

"If there's not a resolution as to how we're going to eliminate the bad assets from the banks' books, there could be another panic, easily," Davis said.

But the Citigroup news is at least sign that the banks are doing better business, even in a deepening recession.

"Once we get past the balance sheet issues," Davis said, "the industry outlook is pretty good."

Deutsche Bank analyst Mike Mayo wrote in a note that "banks can partly earn their way through the problems." But he predicted bank loan losses could rise from 2 percent to 3.5 percent of total loans - surpassing the loan losses that hammered banks during the Great Depression.