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Our Take: Talking Their Book?

Wall Street chieftains are waxing optimistic that an end to the credit crunch is in sight. Should you believe them? More important, should you care?

Morgan Stanley's John Mack declared last week the U.S. sub-prime mortgage problem is "in the eighth or ninth inning," and the broad credit markets will be on the mend by year-end. JPMorgan Chase's Jamie Dimon said the crisis is "maybe 75 percent to 80 percent" over. Richard Fuld of Lehman Brothers also said the worst is behind, and Goldman CEO Lloyd Blankfein said the crisis is "closer to the end than the beginning.''

Job candidates and shareholders have ample reason to be skeptical of these pronouncements. A chief executive who makes public predictions about the broad market is usually talking his book. They may take a dour view of market conditions, as Merrill Lynch's John Thain did when explaining first-quarter results that fell shy of expectations. Alternatively, they may highlight the sunny side, perhaps hoping their positive talk will help dispel the epidemic of risk aversion that's denting their profit outlook.

As Bloomberg News and a number of analysts have observed, these firms were optimistic - and wrong - earlier in the current downswing. (Full disclosure: So were we.)

As long as bank profits are vulnerable to further write-downs, risk-taking and deal-making will be constrained, and the hiring and compensation outlook will remain under pressure. A friendly Fed will help. But ultimately the measure of its success will be the pace at which banks manage to wean themselves off the unconventional liquidity spigots the Fed and other central banks installed around the turn of the year, then opened wide when Bear Stearns blew up in mid-March. In fact, Wall Street securities dealers have borrowed less Treasury securities from the Fed the past two weeks - a hopeful sign that bears watching.

Money Markets Show Little Relief

Still, on balance, the signs from the trenches don't inspire much comfort. Short-term financing markets remain in a deep funk. Spreads between international interbank lending rates and the domestic policy rates set by the Fed and other central banks recently widened to new highs in the 80 - 100 basis points range, according to the Financial Times. On this measure, banks' borrowing costs are five to six times the levels that had held steady for several years before the credit crunch erupted last summer. In another sign of strain on money markets, the British Bankers' Association acknowledged this week that some member banks might be lowballing the rate quotes used to compute Libor - the most widely used overnight rate benchmark - in hopes of limiting their own funding costs. Besides directly impacting banks' costs - which in turn affect decisions about every conceivable activity, from lending to hiring - money market rates are a good gauge of the degree of anxiety among global financial institutions.

Anxiety is afflicting buy-side institutions as well. BlackRock, a high-flying asset management firm 49 percent owned by Merrill Lynch, posted lower than expected profits because fearful clients moved assets out of bond funds and into cash. (For BlackRock as for other investment managers, cash equivalents generate lower fees than portfolios of bonds or stocks.) BlackRock CEO Laurence Fink told investors the firm is trying to persuade its institutional clients to take on more risk and "move away from Treasury-oriented strategies to more credit-oriented and mortgage-oriented strategies," according to the New York Post.

Bright Spots: Interest-Rate Products, FX, Small Investors

Which business lines shined in the latest wave of financial results? Merrill Lynch had record revenue from interest-rate products and currencies. And Merrill's 16,600 retail brokers and their support staff were spared in its latest layoff announcement.

Record first-quarter profit at Charles Schwab also suggests the retail brokerage business remains healthy. Schwab opened 246,000 brokerage accounts and attracted $41 billion in customer assets, a figure surpassed only by the first quarter of 2000, right before the tech bubble popped. The past quarter's $305 million net income surpassed even the 2000 first quarter.

Part of Schwab's influx stems from widely reported troubles at E-Trade Financial, a key rival. And Schwab too has been burned by mortgage exposure: its YieldPlus short-term bond fund suffered major losses from mortgage-backed securities, causing large-scale redemptions and at least one customer lawsuit.

AUTHORJon Jacobs Insider Comment

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