Montreal, Canada

Since the stock market low on March 9 investors have been drunk with enthusiasm sending all risk-based assets skyrocketing following a relentless pounding since late 2007. And bank stocks, which hit a 19-year low on March 6 have since rallied a cumulative 104% as measured by the iShares Financial Select SPDRs or XLF.

But one of the major triggers of this financial crisis has yet to be cleansed: Toxic bank assets.

Since late 2007, former Treasury Secretary Hank Paulson and newly appointed Obama Treasury Secretary Tim Geithner have proposed different solutions to clean battered bank balance sheets by segregating bad assets vis-à-vis TARP or PPIP. Yet nothing has been done to eradicate bad loans still sitting on bank balance sheets.

The U.S. government initially pledged to buy toxic assets from banks to help them recover from the crisis but this directive has yet to be legislated or put into action. Bad loans are still on the books and other segments of distressed or potentially bad loans like commercial real estate are now starting to waffle.

Instead, the FASB (Financial Accounting Standards Board), under pressure from Congress and bank lobbyists fudged the accounting rules last month allowing toxic assets some leeway in how they’re valued. Allowing bank CEOs to determine the value of toxic assets is not true accounting; hocus-pocus trickery won’t fix the problem.

Also, U.S. banks – in the auspices of a soaring stock market – have successfully raised about $65 billion of fresh capital since April.

With the U.S. banking system apparently stabilizing since April, investors have decided to boost the value of financial services stocks – apparently disregarding the crisis and the underlying fact that many of the largest banks have not cleaned house.

From the beginning of this credit collapse the idea was to segregate bad assets into a separate entity allowing banks to finally write the value of bad loans off their books. This has not happened. Instead, every time the market has tanked since late 2008, either Paulson or Geithner have rushed to present new ideas to rescue the banking sector with zero follow-through or no policy action.

Eventually the government will have to either partially or fully nationalize the likes of Citigroup, Bank of America and other battle-scarred institutions. The problem won’t go away until bank books are cleansed. In the meantime, Federal Reserve bank-loan surveys continue to show anemic lending since late last year as financial institutions largely hoard cash and rebuild capital to cushion more bad loans in the future.

In the absence of the expansion of bank credit it’s pretty hard to envision a sustainable economic recovery this year. The economy won’t grow without bank lending – and that won’t happen until banks are confident bad loans are finally at their nadir, which is certainly not the case in mid-2009.