What’s Really Going on with Big Banks

The scoop on what’s really going on with big banks.Big bank stocks have had a tough year in 2011. They’ve been beaten and bruised. Some big banks, like Belgian financial giant Dexia, have needed a government bailout. During the past week, all of the big banks have had a strong rally due to the added liquidity provided by the Federal Reserve and world central bankers, but do we really know what’s going on behind the scenes?

Big banks’ stocks are tied in with the economy, no question about that. If we look at recent news on home prices by the Case-Shiller index, they reported a fifth consecutive monthly decline. The overall index dropped 3.9% from last year; certainly not a great sign. But domestic mortgages are just a slice of what big banks do. They also invest in many markets, including banks in Europe.

What have been quite surprising were the recent revelations that some European countries are putting pressure on their own big banks to buy their sovereign debt. This is interesting, because investors, rating agencies and regulators want big banks to hold less risky bonds, yet their own government is telling them to keep buying! Do you choose the fire or the frying pan?

It’s one giant circle! The government wants their big banks to buy sovereign debt. When the sovereign debt goes bad, the big banks get in trouble and get a government bailout. Then the government needs money, since the economic situation is so bad, so it raises funds by selling sovereign debt…to the banks again. Even the Indy 500 eventually comes to an end after all those circles; at some point, this will, too.

The next few weeks are crucial, with a lot of government bond supply that will be sold in the market. It needs to be sold at rates that the governments can afford, which means you need active buyers. This will continue to put pressure on the eurozone big banks to buy their own sovereign debt, even if they know it’s a high-risk investment.

The opposite of high risk is no risk. Reports are surfacing that, the during the bailout period, the U.S.big banks made a fortune from secret government money. Of the total income for big banks during the bailout period, almost a quarter, or $13.0 billion, was made from bailout funds provided by the Federal Reserve, according to Bloomberg.

This was a free-for-all. If you needed help, you got it. If you didn’t need help but wanted to make money off taxpayers, no problem; you got that, too. Altogether, the Federal Reserve had committed over $7.0 trillion to rescuing big banks. Yet, after all of this pumping, the big banks stock prices are getting back to their lows. Investors are still unhappy with the balance sheets of big banks and have lost faith that they can fix the problem on their own without the help of the Federal Reserve.

What a shocker; as big bank shares scrape the lows of the year, here come the Federal Reserve and central banks around the world to the rescue! The Federal Reserve and world central banks reported this past week that they are again ready to pump more money into the financial system. People are getting excited with the prospects of more easy pickings. I can’t argue with that line of thinking; as the saying goes, “Don’t fight the Fed.” But it makes me wonder: who are some of these brilliant people who run the big banks and how can they continue to operate when their key to success apparently is due to government bailouts from the Federal Reserve?

In the short term, follow the money. I prefer investing in commodities like gold and oil. This takes away the influence of humans who make a lot of costly mistakes. It’s tough to say what will happen to the balance sheets of the big banks in the long run. But we do know that fresh liquidity will be washing around the system. Even though we know that some of these big banks are poorly run, it’s too dangerous to bet against them…just yet. Patience is a virtue!