Is Wall Street pay really bouncing back?

Suddenly, big bucks are back on Wall Street. Analysts believe that bank bonuses will hit new records this year, with Goldman Sachs (GS) shelling out $20 billion and Morgan Stanley (MS) due for $10 billion to $14 billion. That easily tops record levels in 2007, a year that was, for its first half at least, the Shangri-La of record profits for many banks.

After two years of bank runs, government intervention, fears of nationalization and the fall of two securities firms, it's tempting to believe that our long national bank nightmare may finally be over. As PIMCO strategist Bill Gross mentioned in his widely watched outlook, "There is a developing optimism that we can go back to the lifestyle of yesteryear."

But at a time when other industries are suffering, the economy continues to languish, and today's job report was dismal, record bonuses on Wall Street seem shameful, if not laughable. And they are. Indeed, any insistence that record bonuses are on the way should be met with considerable skepticism, particularly if the implication is that Wall Street banks are now healthy and creating sustainable profits. There are some reasons bonuses may modestly grow this year. Revenues are up, and headcount has fallen 10 percent to 15 percent as banks laid off large chunks of their staffs. Banks are also making money because three large competitors were taken out of the business or merged: Lehman Bros., Bear Stearns, and Merrill Lynch. More money split among fewer people means bigger bonuses.

But if bank profits are up significantly—particularly in the second quarter—that may not be good news. Instead, it may well be that banks are falling back on a risky old standby: mortgage-backed securities. Wall Street started a renewed flirtation with MBS in June, just before the end of the second quarter and—perhaps coincidentally, perhaps not—just in time for the next round of earnings. Data compiled by JMP Securities' Wall Street analyst Michael Hecht show that there was a big spike of 20 percent in fixed-income trading volumes in June, mostly from a 32 percent jump in trading of MBS and a 20 percent rise in trading of Treasury bonds. Prices are also rising. Bloomberg cites data showing that some MBS that were trading at 35 cents on the dollar now sell for 47 cents—more than a 30 percent increase.

Seeing those numbers, you might expect that banks are buying up MBS in order to "buy low and sell high." Probably not. If that were the strategy, there would probably also be a simultaneous, big jump in underwriting of MBS to take advantage of high prices, and that's not happening. Quite the contrary, securitizations are down 40 percent this year compared with last year, which was already a depressed year for underwriting such mortgage securities. Instead, the real strategy banks might be aiming for with MBS might be something more like "buy low, hold high." Bloomberg data show that banks are hoarding MBS on their balance sheets, to the tune of $154.6 billion in mortgage securities, up 5.6 percent from April.

Why would banks want to do this? For one thing, the government wants banks to sell those securities into the Public-Private Investment Program, or PPIP, which aims to clean up bank balance sheets by making the government a broker and financier between banks selling toxic assets and private-equity firms buying them. Because the government is financing such deals, banks may well be able to sell the mortgage assets at relatively high prices. But PPIP is stumbling; even Treasury officials concede that it is no longer entirely necessary and that banks have been largely pursuing what one commentator called a "pray and delay" strategy, hoping the program would bust.