Banking woes seem to ease. Is it a sign?

Evidence of stability includes easing US bond prices and bank moves to raise capital.

By , Staff writer of The Christian Science Monitor

The turbulent times for banks aren't over, but suddenly it seems that bankers have a bit more opportunity to breathe.

It's been a month since the overnight collapse of Bear Stearns, and it appears that policy moves by the Federal Reserve have helped to restore a sense of order to financial markets. Wall Street hasn't been rocked by further corporate earthquakes, and executives at some investment firms are saying the worst of the crisis is over.

Saying so doesn't necessarily make it so. The economy still faces broader concerns over housing woes and oil prices that could delay a recovery. But some signs of stability are emerging:

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•Mainstream banks announced big quarterly losses this week but also moved to raise fresh capital for the future.

•Investment banks, which are also exposed to souring home loans, have reduced their borrowing from the Federal Reserve for two weeks in a row – a trend that may reflect reduced stress.

•Investors have backed away from a panicked "flight to safety," with Treasury bond prices falling as fewer people rush to buy them.

"After Bear Stearns's crisis and the Fed's strong actions ... things seem to have stabilized somewhat," says Rajeev Dhawan, director of the economic forecasting center at Georgia State University in Atlanta. "If [banks are] able to raise capital and shore up their balance sheets, then that's a positive sign."

After about eight months where fear and uncertainty have dominated Wall Street, the recent shift in mood is a welcome one. It signals that, despite ongoing problems, bankers hope to manage their way through the mess.

The mess is a large one, however.

The International Monetary Fund, in a report on global financial stability this month, estimated that the crisis centered on US home loans could ultimately shave nearly $1 trillion off the balance sheets of banks, insurance firms, investment companies, and government agencies.

The IMF's estimate of $945 billion in losses includes effects of a broader economic slowdown, as high oil prices and falling home values shake consumer confidence. Mortgages are the biggest worry, but the report also predicts losses for everything from credit cards to commercial real estate and corporate loans.

If that scenario proves accurate, with roughly $1 in every $23 in loans going bad, some banks will fail, analysts say.

The uncertainty about which banks are most at risk, together with the pressure to conserve cash to cover their losses, continues to make banks reluctant to lend to each other as they normally do to cover short-term needs.

"The problem right now is the banks are not lending to each other," Mr. Dhawan says.

The financial crisis will hinge on how the economy performs in the months ahead.

Consumer spending is already strained by high energy costs and a reduced pool of housing wealth to borrow against. The more consumers struggle, the more loans could go bad.

But several forces could help avert a deep consumer-driven slump. Dhawan predicts that oil prices will decline later this year, in tandem with the cooling economy. He adds that corporations have lean staffing already, so that a recession may not mean such large job losses as it has in the past. The dollar's weak value, meanwhile, is helping to spur demand for US-made exports.

Such factors may help explain why the stock market has stayed relatively resilient in the face of the economic slowdown. And why banks see light in the tunnel.

"I think the worse is behind us for financial markets," says Michael Darda, chief economist at MKM Partners, an investment firm in Greenwich, Conn. "It doesn't mean the worst has been seen in terms of the economic data," he adds, but in forward-looking indicators "there's really been improvement across the board."

The price of investments called credit-default swaps, for example, now indicates less risk of default on corporate debt.

And the annualized yield on two-year Treasury bonds – at a long-term low in March – has edged back above 2 percent as fewer investors seek a haven.

The stock prices of financial firms have edged up from the lows they hit in mid-March, around the time Bear Stearns collapsed in what amounted to a panicked run on the bank by its clients.

At the largest financial firms, several chief executives have expressed optimism in recent days. James Dimon of JPMorgan Chase said the crisis is "maybe 75 to 80 percent" over. Lloyd Blankfein of Goldman Sachs said "we're closer to the end than the beginning."

John Mack of Morgan Stanley said the crisis will go on for "a couple of quarters longer," and used a baseball analogy to tell investors that one part of the problem – the declining value of subprime mortgages – is in the eighth or ninth inning.

These upbeat statements come with caveats, and not all bank CEOs have joined the chorus.

For many banks, the biggest exposure is to home loans. So a key question is how far home prices fall in the current weak market.

Congress is considering various moves designed to reduce the number of defaults, since foreclosures end in "fire-sale" auctions that push home prices down further.

But it's not clear whether major legislation will be passed into law this year.

"We're at a very risky point in this process," says Scott Lilly, a financial expert at the Center for American Progress, a left-leaning Washington think tank.

He says that when loan losses pile up, they end up eroding the capital that banks need as the underpinning for new loans.

That's why it's good news that many banks are scrambling to raise fresh supplies of capital.

Even as banks unveil losses on loans, troubled National City Corporation in Ohio announced a $7 billion infusion from investors on Monday. And Tuesday, Royal Bank of Scotland said it plans to raise $24 billion.

Where the losses land in financial crisis

The credit turmoil spawned by a US housing slump and related economic slowdown could cause nearly $1 trillion losses out of $23 trillion in outstanding loans and loan-related securities. About half the problem rests with banks, half with other institutions.

Potential losses, in billions:

Banks $440-510

Insurers $105-130

Hedge funds/other $110-200

Pension funds $90-160

Government* $70-140

Total $815-1,140

*Including independent enterprises with government sponsorship, such as Fannie Mae.

Source: International Monetary Fund staff

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