Is Financial Recovery A Mirage?

There is a new feeling suffusing the financial markets that the worst of the credit crisis is over. The Fed has done most of its work. US citizens are about to get their tax rebates. Large financial companies like Citigroup (C), Merrill Lynch (MER), and Lehman (LEH) have raised enough money to keep their heads above water.

All of that may not be as likely as it seems. Goldman Sachs has put the damage of the current housing and credit crisis at $500 billion, which means that the profuse bleeding in the system has not been stanched.

According to Reuters “Goldman Sachs economists expect a total of $500 billion in residential mortgage credit losses, a renewed slowdown in economic activity after the near-term boost from fiscal stimulus, and no monetary policy tightening in 2008 or 2009, according to a research note from the firm.”

It is a pessimist’s case which is deeply disturbing. But, it has begun to show in share prices, if the market is, indeed, wise.

Looking back over the last six months, the stocks of Citigroup and Lehman were both off 50% from November to March. Those deficits had closed to only 20% two weeks ago. But, they have now both slipped to being off 30% since November, a sharp move down in such a few days.

The bull case for financial stocks is that the Fed and investments from sources like sovereign funds have saved them. The bear case is that the fundamental troubles with mortgages and consumer spending are a deep undertow which will surreptitiously begin to drag them out to sea.

The housing and mortgage crisis is getting worse and that trumps all other cases.

Douglas A. McIntyre