Montreal, Canada

Are the banks out of the woods? It would seem that several of America’s largest financial institutions have escaped their Day of Reckoning as stocks prices have surged over the last four months. Though the largest banks are breathing a sigh of relief lately the regional and smaller banks in the United States are next on the chopping block as commercial loans continue to sour.

LIBOR, the Ted Spread and other important short-term credit indicators have normalized over the last few months as credit stress eases. Inter-bank lending rates have indeed collapsed and the largest institutions are lending again overnight. But most banks are hoarding cash and not making loans. LIBOR doesn’t convey this vital money trail.

The trigger for the bank sector recovery earlier this spring was the FASB’s reversal of accounting rules in May, basically allowing bank CEOs to fudge their books by self-determining the value of assets on their books – including illiquid toxic assets. The FASB caved-in to Washington and bank CEOs.

The way I see it, the entire financial system remains a casino governed by a bail-out mentality, encouraging risk and then forcing taxpayers to foot the bill when the next crisis unfolds. Worse, retention bonuses are still widespread – some of it paid by taxpayers. We’ve really learned nothing over the last 24 months.

For the biggest banks, the post-March 9 rally has been a life-saver. Many banks have come back from the near-abyss in the first quarter and have successfully raised about $70 billion dollars of fresh capital since April. But despite TARP, PPIP and TALF the banks are collectively still hoarding cash and not lending to businesses and consumers. The Federal Funds rate is at 0% for a reason; the demand for credit is just not there.

What about the $700 billion TARP that Congress legislated last fall? Most of that money is only being channeled into the economy over the next two years while funds already deployed in 2009 have mainly gone to the states (only about 8 or so are solvent). The truth is nobody can really account for the money; there’s no record of disbursements and the public has no clue who’s getting what.

Any money consumers receive from the government will likely be saved, not spent.

Consumers are still rebuilding battered balance sheets and in this deep recession won’t be binging for goods and services any time soon – let alone a new home. The job market hasn’t stabilized and most consumers are more inclined to save as depicted by the spike in savings as a percent of disposable income, currently at 6.9%. As savings rates rise consumers spend less. The historical relationship between a rising savings rate and corporate earnings isn’t a pretty one.

Meanwhile, the majority of U.S. banks are not lending capital in an environment of chronic spare capacity, deflation in prices and rising job losses. What savvy banker in today’s market wants to lend?

Regional and small banks are next on the hit list. These institutions probably don’t threaten systemic risk and therefore won’t get a bail-out. That’s too bad because lenders like CIT and many others form the hallmark of bank credit to rural and small businesses. Time will tell if the stock market is punch-drunk or about to take more investors to the cleaners – exactly what’s occurred since October 2007 amid several false rallies.