Banks' Valuations Just Got More Justified

Is the most important story in any media outlet this morning being ignored? I am talking about the "Unwound CDOs Give Relief to Wall Street" lead story in the Financial Times. (Also see coverage of this issue on TheStreet.com.) We all recognize that there are many, many negatives on the balance sheets of America's banks and insurance companies, ones that many bears think have simply been ignored.

The banks have had four sets of problems: whole residential loans, whole commercial loans, credit card debt and collateralized debt obligations that were taken on to boost the bottom line at a time when rates were so low that the banks had to reach for yield to deploy their cash.

Slowly and surely, the banks are dealing with each of these. The end of house price depreciation and the spike in existing-home sales have been godsends for the banks. Further writedowns have been forestalled at the same time the workouts are getting to a meaningful level at places like Wells Fargo (WFC - commentary - Trade Now) and Bank of America (BAC - commentary - Trade Now).

Credit card debt charge-offs, according to Capital One (COF - commentary - Trade Now), American Express (AXP - commentary - Trade Now), Target (TGT - commentary - Trade Now) and Discover (DFS - commentary - Trade Now), peaked in the second quarter.

Commercial? I am using the iShares Dow Jones U.S. Real Estate (IYR - commentary - Trade Now) as my judge, and it is putting in a nice base.

Which leaves CDOs. I don't think Wells has any exposure left to these products. But Bank of America, through Merrill, and Citigroup (C - commentary - Trade Now), through its structured investment vehicles, have a ton. The bears think the stuff is worthless. But if they can be unwound, these pieces of paper can come back to life.

Of course, the bears can say that the paper was never written down, so it doesn't matter. But you cannot have it both ways. You can't say it is worthless and not written down and then find out it is worth something and not written down. The gulf between the reality and the Pollyanna accounting just grew much smaller for these black holes. That's the takeaway of this great article.

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