Issue of the week: Is the worst over for banks?

To get a sense of the ragged state of the U.S. banking industry, said David Enrich in The Wall Street Journal, consider what now passes for good news. When Citigroup, the largest U.S. bank, reported a $2.5 billion quarterly loss last week, analysts and investors actually “were encouraged.” And when Bank of America, the second largest bank, reported this week that its second-­quarter profits fell 44 percent from the same quarter last year, Wall Street greeted the announcement as a pleasant surprise. The reason for the surprisingly upbeat reaction to the apparently horrible news is that analysts can see that banks are facing reality and “writing down their piles of bad assets.” Write-downs occur when a bank’s assets—mostly loans, bonds, and other securities—are

worth less than the price the bank originally paid for them. Accounting rules require the bank to “write down” the value of the asset to its current price; the difference between the original price and its current value is deducted from the bank’s earnings. It’s a lengthy and painful process, but it’s better than the alternative. It may seem strange to put a positive spin on massive losses, but Wall Street’s optimists reason that “the moves reduce the odds of gigantic future write-downs.”

Unfortunately, it’s too soon to say the worst is over, said Eric Dash in The New York Times. Now that the banks have tallied most of the losses they’ve incurred on subprime mortgage securities, problems with other assets are cropping up. A growing number of Bank of America’s credit card customers are falling behind on their payments, and defaults on construction loans are creeping upward. “The bank is also experiencing heavy losses from loans made to small-business customers.”

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Even Treasury Secretary Henry Paulson is admitting how bleak things look, said the Associated Press. Paulson’s job virtually requires him to make optimistic noises about the economy, but now he is “bracing people for more troubled times ahead.” Paulson said this week that it would be months before banks know just how many bad loans they have on their books. In the meantime, more undercapitalized banks will fail, joining California’s IndyMac Bank, which the Federal Deposit Insurance Corp. took over a couple of weeks ago. Paulson nonetheless tried to reassure Americans that they have “a safe banking system, a sound banking system.” The nation’s financial regulators, he said, are “being very vigilant.”

Too bad they weren’t more vigilant before the housing market tanked, said James Grant in The Wall Street Journal. “Never was a disaster better advertised than the one now washing over us.” Housing prices leveled off in 2005, and “cracks in mortgage credit started appearing in 2006.” Yet the banks continued to make mortgage loans as if the boom would never end, and “the government’s snoozing watchdogs” did nothing to stop them. In the past, Americans would have demanded that those responsible pay the price for their negligence. This time around, though, populist anger is notable mostly for its absence. Where’s the outrage? Perhaps “today’s financial failures are too complex to stick in Everyman’s craw.”