In a contributory post that I made for another site, one of the commenters alleged that it was misleading to say that the failed bulge bracket banks had backing from the Federal Reserve, or else they wouldn't have failed. This is simply not true. The blessing of the government does not necessarily cure all of your ills. The Federal Reserve opened its discount window to the remaining bulge bracket banks after Bear Stearns (Is this the Breaking of the Bear?) filed for bankruptcy. It even decided to allow much lower grade collateral, degrading its standards to the point where it took stock and MBS, if I am not mistaken. This liquidity backstop (among other programs) did not prevent the collapse of Lehman Brothers, nor the very near collapse of Merrill Lynch. The remaining two bulge bracket banks were literally forced to become commercial banks to stave off their downfall. This history is barely a year old and is already lost on some.

What the government's efforts did was backstop the liquidity of these banks, but the liquidity issues were a symptom of the bank issues, not the cause of the bank issues. The cause of the problem was, and still is, insolvency. I went through this in detail, exactly one year ago when Lehman and AIG went bust (Why didn't the Fed drop rates? Because it would have done little good). Here is a chart and excerpt from that post of over a year ago. If one were to chart the stocks of the companies that are in that chart, I am sure the solvency vs liquidity argument will be gelled, at least to some point...

_{Click to expand the chart...}

The primary reason why the Fed's lowering of the interest rates is not helping the banks is because monetary stimulus via discount windows and low interest rates can solve liquidity issues, which the banks have - but the banks liquidity issues stem from INSOLVENCY, and illiquidity. Thus, all the Fed is doing is taking a pricey, risky (inflation and weakening currency that pisses off our trading partners) and volatile band aid and applying it to deep and gushing wound. Those band aids with the pretty colors do indeed tend to make Mama's baby's little boo-boo feel better, but from a scientific perspective do very little in regards to addressing deep puncture wounds.

 As it turned out, the Fed did drop rates more, eventually to effectively zero. Guest what happened? NIM still dropped at many sick banks, and quite a few of them went out of business, and it is still happening at nearly a record pace. The FDIC has actually been driven into insolvency just a year after my warnings on the insolvency of the banking industry - reference my recent missive: "I'm going to try not to say I told you so...".

In "The Anatomy of a Sick Bank!" from over a year and a quarter ago were I again attempted to drive this concept of insolvency and the inability of liquidity bandages to stem the problem home. As excerpted:

"Let me explain the five major tenets of the sickness troubling banks these days.

1. An absolutely horrible macroeconomic environment with the convergence of a downward banking business cycle, a bear market approaching, and recession.
2. Rapidly depreciating assets borne from excesses during the recent real asset and credit bubble.
3. High levels of these rapidly decreasing assets on (and off) the books of many banks
4. High levels of leverage (the highest historically) used to purchase the aforementioned. Leverage which exacerbate both profit and loss (we are in a loss moment, now). The combination of this high leverage and the prices paid for the assets mentioned in point 2 create an INSOLVENCY trap for companies that attempt to reduce risk by delevering (ala Lehman Brothers or Citibank). When in this situation, the only way to reduce risk is to realize significant losses (and some banks are trying to hide them).
5. Thin profit margins that are beyond the ability of the government to help. The banks can't earn their way out of this one.

This all basically leads to insolvency if not corrected timely. 

This is an insolvency issue, not a liquidity issue! I have been banging the table on this for almost a year... 

As concluded in the bullet list above, the trifecta of diminishing margins, increasing insolvency, and high leverage leads to a sick bank. I would like to delve deeper into each symptom and side effect in order to identify the sickest amongst the Doo Doo.

Insolvency exists for a person or organization when total financial liabilities exceed total financial assets. Financial and real estate institutions that have binged on overvalued risky assets at the top of a bubble, paying for said assets via highly leveraged credit, are now facing the effects of the devaluing of those assets and that devaluation being applied against the excessive debts that have been accumulated to buy those assets when they were bubblicious."

The only thing saving the big money center banks are their trading arms and the government complicity in masking their insolvency issues as liquidity issues through opaque accounting. The credit quality of assets and the general traditional banking business is performing horribly, across the board of the big money center guys and many of the regionals. The trading revenue spike has its costs, too, which is apparent as I parse through the lastest results of JP Morgan, which I will post a little later on, followed by a continuation of my off balance sheet series featuring Wells Fargo.

Re, JPM: The high trading revenue comes at a cost of high market risk which is reflected in higher VaR levels. The fixed income VaR has increased substantially and stood at $243 million at the end of 3Q09 against $183 million at the end of 3Q08.