inventories

Ben Bernanke, in a fit of wild optimism, told us that he saw ‘green shoots’ of recovery springing up around the economy.

Not this morning I think.

If real estate is anything to go by we are still in full recessionary mode. Housing starts in March fell 10.8%, to a level that is the second worst since the middle of World War II, a time that home building presumably had a very low national focus. The worst month? January. It was the modest uptick in February that sparked so much of the ‘green shoots’ spotting that surged through the media in the past two weeks. To make matters worse, permits issued for new construction also fell to a record low – 513,000 – so there doesn’t seem to be any prospect of a real estate recovery any time soon.

Couple this with the bankruptcy of General Growth Properties, the nation’s second largest mall operator, and the outlook gets dimmer. General Growth is the owner and operator of such places as Faneuil Hall in Boston and South Street Seaport in Manhattan. Their failure is a sure sign that poor retail store sales and retrenchment by retailers will create a wave of distress amongst property owners. In fact we should all be on the look out for a surge in commercial property bankruptcies as real estate owners all reach the limits of their loan repayment forbearances and are unable to fund their debts any more. General Growth’s collapse is probably just the beginning of the commercial property sector’s problems.

Which is why I remain skeptical about all the bank earnings reports being published this week.

JP Morgan Chase attracted some good press this morning when it announced very healthy income, down 10% on last year, but still positive. If we are to believe these numbers are solid, then they along with similar shows of strength from Wells Fargo and Goldman Sachs could indicate the beginning of the end for the banking sector’s travails.

But.

Somehow I don’t think the banks are being upfront with us.

In particular their loan loss provisions – the amounts they set aside to cover future loan losses – appear inadequate. No other line in a bank’s income statement is subject to so much management discretion. Basically a banks’ executives can manipulate earnings by increasing or decreasing the provision, and they can always argue that whatever they do is the result of their ‘best estimates’ or ‘considered judgments’. Don’t believe a word of it. Those provisions should be very high right now. Not only are they all struggling with piles of toxic assets from before the recession, but now with commercial real estate tanking and rising unemployment sending credit card defaults through the roof, bank provisions should be approaching their high water mark.

Take two numbers from JP Morgan this morning. They tout their provision as being very solid at 4.53% of total assets. And they reveal that their credit card portfolio had a default rate of over 9% in the first quarter and seems to be getting worse rapidly. Given a deteriorating credit card portfolio, the imminent losses in commercial real estate, and the fact that the economy is still shrinking – in particular unemployment looks set to keep rising for a few more months – I would argue strongly that even at 4.53 % their provision is inadequate. Future earnings will more than likely be depressed by losses that the provision cannot cover.

Further: JP Morgan, like all the big banks has a ton of taxpayer cash to bolster its capital. That is low cost funding and should allow the banks to generate extra income so they can rebuild their own capital. Indeed giving the banks low cost funding in order to increase their earnings was one of the unwritten goals of TARP. Clearly TARP has succeeded in this respect. But, now the banks need to get themselves of of the taxpayers books. to do this they have to replace TARP money with private capital. And to attract private capital they need to show a strong and sustainable earnings recovery. Hence all that ‘judgement’ about provisions. JP Morgan Chase has a Tier 1 capital ratio – the capital that the regulators look at as the best sign of bank strength – of just over 11%. Take away TARP money and that ratio falls to around 9%. Since the regulators are likely to be looking for ratios higher than before when 10% was considered good, JP Morgan Chase has a way to go. It is not out of the woods by any means.

So, the real estate market belies Ben Bernanke’s ‘green shoot’ comment. And so does the banking sector, even with all these ‘good’ earnings reports.

We still have a long way to go.

The inventory turn around I expect in the fourth quarter is still our best bet to halt the decline. Until then it will stay bumpy.