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Bank losses not as bad as Street had feared

This week's midyear corporate financial results offer some hope that the banking industry is working its way through the worst of the damage from the mortgage meltdown.

As the midyear earnings season gets into full swing, closely watched results from the banking industry offer some hope that lenders have seen the worst of the damage from the mortgage meltdown and housing crisis.

But with housing prices still falling and inflation on the upswing, the outlook is cloudy, analysts say.

On Friday, industry giant Citigroup reported its third straight quarterly loss, although the $2.5 billion in red ink was less than what Wall Street had expected. Citigroup shares jumped, even though the banking company has lost $17.4 billion and written down the assets on its books by some $58 billion since the credit crisis began last year.

For the most part, other banks have also averted the Wall Street’s worst fears. Results for Wells Fargo and JP Morgan Chase also came in better than expected.

“The numbers are nowhere near as bad as people expected,” said Richard Bove, who follows the banking industry at Ladenburg, Thalmann. "When we went into this quarter, the expectation was high that banks would lose so much money that they would be forced to announce more dividend cuts, more capital raises. And that, in fact, just has not happened."

That relatively good news from the banking industry has helped the stock market stage something of a rally this week that lifted the Dow Jones industrial average by nearly 500 points off its lowest levels in two years.

So far, profit reports from companies in other industries have been mixed. Shares of Microsoft sank more than 5 percent Friday, a day after the company missed Wall Street's earnings forecast by a penny, and issued softer-than-expected guidance for the current first quarter. Microsoft cited weakness in its online business, which makes most of its money from Web advertising.

(Msnbc.com is a joint venture of Microsoft and NBC Universal.)

Microsoft rival Google also saw its stock hit Friday after the Internet search leader's second-quarter earnings missed analysts' expectations. Economic turmoil in the United States and parts of Europe appears to be causing consumers to click less frequently on the ads that generate virtually all its profits, company executives said. That news dashed some investors hopes that Google might be immune to the economic slowdown, said Clayton Moran, a media analyst with Stanford Group.

“They finally admitted that the consumer slowdown will impact their business,” he said. “We're now seeing a broadening of the advertising slowdown and a lot of fears that it will be prolonged. So if Google is going to be impacted, then that impact will last as long as this slowdown lasts.”

That’s why analysts and investors will be listening closely in the coming weeks to hear what companies have to say about their forecasts for the coming months — especially those that rely heavily on consumer spending, which accounts for about 70 percent of U.S. economic activity.

Despite the drop in home values and rising unemployment, consumer spending has held up relatively well, helped in part by the government’s $100 billion tax rebate and interest rate cuts from the Federal Reserve.

Rising prices — especially for oil and energy — pose another big wild card for corporate managers trying to forecast what lies ahead. After a sharp pullback this week, oil prices were up slightly Friday as news of an output cut in Nigeria helped reverse the recent slide.

But underlying all the other economic news, the housing industry recession grinds on.

The financial industry is continuing its painful process of working through hundreds of billions of losses from the mortgage meltdown, unwinding the leverage built up after years of building portfolios of mortgage and mortgage-backed bonds that magnified profits when times were  good but amplify the pain now that times are bad.

That’s why banks and brokerages have been hit so hard by falling home prices and the rise in mortgage defaults and home foreclosures. They have been forced to sell off troubled securities at fire-sale prices.

“In the last quarter, there was about $900 billion-plus of deleveraging from the Goldmans, Morgans, Merrills, selling assets,” said David Katz, chief investment officer of Matrix Asset Advisors. “When you're selling those assets, you're not getting great prices.”

Some big financial companies like Merrill Lynch and Citigroup are still holding onto some of those assets, hoping they soon begin recovering their values. But their portfolios will remain under pressure as long as the housing recession continues.

With home prices still falling and would-be buyers facing tougher credit terms, the housing market is stuck in its worst slump since the Great Depression.

On Thursday, the Commerce Department reported that construction of single-family homes nationwide fell to the slowest pace in 17 years. Most forecasters believe the housing market won't recover before next year at the earliest.