Banks have so far written off $500 billion in bad debt, thanks to their exposure to the subprime mortgage market.

But now, despite a continuing credit crunch, bank stocks are bouncing back up. Is this a signal that banks have bottomed? Or is there more pain to come in this beaten-down sector?

Andrew Gordon in Investor’s Daily Edge is bearish on the outlook for the sector. He says banks are still running on empty. And with the rate of foreclosures rising in the US, this is no time to buy in. Steer well clear until the economy picks up…

Roughly one-year after the onset of the credit crunch, the banking index is showing a great deal of volatility. Last Thursday the KBW bank sector index was up 3.5 percent. The day before it was down over 5 percent. Last Tuesday it was up 5.5 percent.

Such volatility indicates that investors don’t know quite what to make of banks at the moment. I don’t understand. This is no “glass half full or half empty” dilemma. Banks are pretty much still running on empty. Consider:

* Banks are claiming that their writing-down days are coming to an end. We’ve heard that whopper before. Why should we believe them now?

John Thain, CEO of Merrill Lynch, is the poster boy of lying CEOs. But he has to share the stage with Alan Schwartz (Bear Stearns), Vikram Pandit (Citigroup), Ken Thompson (Wachovia) and many others.

Time and again, banks have been forced to confess that their books are much worse than they had let on.

* I’ll believe their actions – when they stop writing down – and not their words. Banks are still writing down. Enough said.

* Foreclosures are picking up rather than slowing down. Pending home sales are down over 12 percent from last year. Some 30-40 percent of these sales are distressed/foreclosure sales – not exactly the type of sales that mark a bottom to the housing market.

* How much are these banks’ underwater loans worth? Merrill Lynch just sold off a chunk for 22 cents on the dollar… and they even financed the sale. Such sales help clean up banks’ books. But it drives home the point that these banks are still sitting on billions of dollars of nearly worthless paper.

* And as I said last week in IDE, hundreds of banks are expected to fail this year. There were no failures in 2005 and 2006 and only three in 2007.

It’s pretty clear to me that banks haven’t bottomed yet. This is no time to start buying banks.

To top it off, how are these banks going to make their money, even after they’ve finished writing down the rest of their bad debt? The economy is terrible. And their once-upon-a-time lucrative derivative market has completely dried up.

Source: Banks Haven’t Bottomed Yet