Hate the banks if you want. But we need them.

chart_ws_stock_kbwbankindex.top(3).png By Paul R. La Monica, assistant managing editor

NEW YORK (CNNMoney) -- For everyone who railed against the big bank bailout in 2008, this has been a happy week.

Shares of Citigroup (C, Fortune 500), Goldman Sachs (GS, Fortune 500), American Express (AXP, Fortune 500) and Wells Fargo (WFC, Fortune 500) all took a nasty tumble after reporting results that weren't completely up to snuff.


It's interesting that this is happening because, by most accounts, the economy is getting better. So the fact that banks are lagging behind in a recovery has to be considered a delightful bit of schadenfreude.

But it might be a mistake to cheer the continued woes of the big banks. For one, it's not as if smaller banks are profiting at the expense of the industry's giants.

Take a look at Hudson City Bancorp (HCBK) for example. The Paramus, N.J.-based regional bank has long been considered one of the most conservative institutions when it comes to underwriting loans.

Hudson City did not run into the problems that many of its peers did when the housing market imploded. The bank even refused to take TARP money. But Hudson City announced Wednesday that profits in the fourth quarter slipped 11% from a year ago.

In a statement, CEO Ronald E. Hermance, Jr. indicated that "the continued elevated levels of unemployment" and "the weak housing market" were two factors that hurt earnings last year. He added that they would continue to do so in 2011.

That's not a good sign.

"For a healthy economy and market, you need stable financial institutions," said Michael Cuggino, manager of the Permanent Portfolio in San Francisco. The fund owns Bank of New York Mellon (BK, Fortune 500) and State Street (STT, Fortune 500), two trust banks that also reported disappointing earnings this week.

Still, there are some encouraging signs for the banking sector. A long-awaited (and needed) period of consolidation may finally be beginning. In the past month, three notable bank deals were announced.

In mid-December, Bank of Montreal (BMO) agreed to purchase struggling Wisconsin bank Marshall & Ilsley (MI) for about $4 billion. Later that month, Hancock Holding (HBHC) of Mississippi announced it was taking over New Orelans-based Whitney Holding (WTNY) for $1.5 billion.

And just this week, Dallas-based Comerica (CMA) said it would buy Houston lender Sterling Bancshares (SBIB) for $1 billion.

Simply put, there are too many weaker banks out there.

"More merger activity should be positive for the group as a whole. Some banks need to be taken over," said Frank Barkocy, director of research with Mendon Capital Advisors in New York.

Barkocy added that bank stocks usually outperform the market during rallies and economic recoveries. The KBW Bank Index, a leading index of top banks, surged 22% in 2010, outpacing the S&P 500's gain of 13%.

"If we see improvement in the economy and underlying fundamentals of the banks, banks should provide some form of leadership to drive up the market as a whole," Barkocy said.

But the reverse tends to be true as well though, with banks underperforming in a weak market. The KBW Bank Index is down more than 4% in this holiday shortened week. The S&P 500 has fallen about 1.6%.

Barkocy said that bank stocks may have gotten ahead of themselves and that expectations were just too rosy. That's not the same as saying that the group is now in a heap of trouble again like it was in 2008 and early 2009.

Still, there is no getting around the fact that the health of the banks is intertwined with that of the economy. It's unlikely that the banks can continue to languish while the rest of the market goes up without them.

So rooting for the big banks to suffer just isn't smart because it probably means the whole economy is still in lousy shape.

-- The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.  To top of page

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