Bernanke's Conundrum Escalates

 | May 21, 2013 | 4:00 PM EDT
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Last week, I wrote about my concerns about Bank of America's (BAC) ability to continue as an ongoing concern. I did not mean to imply that the other three money centers, JPMorgan Chase (JPM), Wells Fargo (WFC) and Citigroup (C), were in substantially greater shape with their balance sheets or business models. It was simply an observation of the empirical data that Bank of America is in the worst position. 

In general, however, you should be aware of the disturbing trends across the banking sector in general and the money centers in particular, even as their stock prices continue to climb.

The first thing to note is that the total value of all assets at all U.S. banks declined from the fourth quarter of 2012 through the first quarter of 2013, by about $25 billion. The driver was the reduction in the value of loans by about $30 billion.

There was a big discrepancy, though, between the performances of the money centers. JPMorgan Chase experienced a large increase in its assets, about 2.5%, or almost $50 billion. This has been a pretty consistent trend for JPMorgan over the past three years.

By comparison, Bank of America experienced a decline in assets by about 1.5%, or almost $25 billion. Unfortunately for Bank of America, this too is a continuation of a trend that has been in force over the past three years and shows little sign of reversing soon.

There was little change in total assets at Wells Fargo and Citigroup.

The net decrease in assets in the U.S. banking system, though, is the opposite of what the Federal Reserve has been trying to accomplish with quantitative easing. This decline is escalating the debate over whether the Fed should continue with quantitative easing.

Some Federal Open-Market Committee members believe more QE and even lower rates are needed, others the opposite. For whatever reason, though, the current version of QE, the purchase of mortgages and long end treasuries by the Fed, isn't successful.

Another disturbing but related event is that the value of domestic deposits at U.S. banks declined by about $20 billion during the quarter, from about $9.45 trillion to about $9.43 trillion.

This is principally a reflection of a reduction in loans, but it is also indicative of savers searching for interest income and moving into incrementally higher-yielding assets. This particular point is one that all investors should take note of, because there is no next class of asset owners left after that to shift assets into higher-risk, higher-yielding assets.

The logical question to follow is that once the market has arrived at a point where the support provided for private-sector bonds and dividend-paying stocks is coming from savers, who's left to buy?

This provides the opponents of QE with the ultimate "pushing on a string" argument for suspending further stimulus soon.

The flight to safety into the perceived security of FDIC-insured accounts has now been fully reversed by the Fed. The pain of accruing no interest on those accounts is greater than the fear of losing principal in the non-insured arena.

The problem, of course, is that even while housing stabilizes, stocks rise, and risk-taking increases, banks are not lending.

These are the principal issues Fed Chairman Ben Bernanke has to deal with, and investors will be listening for guidance tomorrow.

Fed policy is at a fork in the road. The current structure of quantitative easing is not working. Will Bernanke increase or decrease it? The logical answer is to slow down the rate of mortgage and Treasury buying, as I discussed last week in the column "Advancing in Reverse."

Putting aside the question of whether or not the Fed will begin to remove the current round of quantitative easing, until loan-taking and loan-making begin to increase, the Fed has no logical choice but to continue with such policies.

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