How are banks making record profits?

I need help with this one. I have a serious question, and I think I know the answer, but I need confirmation that I am correct (or correction, if I am not.)

Commercial and investment banks are all of a sudden making huge profits, even though from what I have read, the typical lending and underwriting activities of these institutions hasn't recovered much at all from the economic crisis.

So where is the profit coming from?

Here is what I suspect: The Federal Reserve's balance sheet has ballooned, much of it due to providing massive amounts of liquidity to the banking system in order to forestall collapse. The discount rate (the interest rate the Fed charges member banks when they borrow money from the Fed) is at 0.0%.

Which means the Fed has basically said:

"The government will not let you fail. No matter how bad your own balance sheet, no matter how much your own assets have fallen in value, even if you are completely insolvent from a asset/liability standpoint, we will lend you money so your depositors know they can get their money back if they want it."

Normally, insolvent banks just fail. But in the collapse of 2008 and 2009, both Bush and Obama bought the "too big to fail" line, and the government stepped in to provide banks with the liquidity that the markets would certainly have not.

Which gets me back to my original question: So how and why are these banks making so much money now? Are their balance sheets now healthy? Are their banking activities now generating record revenue? If so, how could this possibly be the case if the economy is still so putrid?

Here is what I am pretty sure is the answer, and I would very much appreciate someone with more recent industry knowledge than myself to confirm this:

Banks are borrowing massive amounts from the Federal Reserve at zero percent, and lending that money to the ..... FEDERAL GOVERNMENT by buying treasury bonds to finance the deficit.

So if you can borrow basically unlimited amounts at 0% and then "invest" it in Treasury Notes at 2-3%, what a great business model! I wish I owned a bank. I'd think I could manage to turn a profit doing that.

So if I am right, this is just the federal government monetizing its debt, with a 2-3% leakage to commercial banks. From the taxpayer standpoint, we get doubly screwed. Monetizing the debt is hugely inflationary, but normally the government can do it without simultaneously enriching the managers of insolvent financial institutions!

So this brings me to the Obama "tough on banks" rhetoric and his bank tax idea. It is so disingenuous. Should these bank managers be earning huge bonuses? ABSOLUTELY NOT! If I am right about the above, their profits are basically just 100% taxpayer subsidy. Why should they make millions by running a government sanctioned scam in which they borrow money from the taxpayers and then lend it back to us for a 3% spread?

The structural damage this causes is almost incomprehensible. First, when does it end? If the Fed stops lending money to the banks at zero percent, or starts charging what the market would charge for banks with insolvent balance sheets, the banks would fail. So is the Fed going to continue to lend at zero until these bank assets somehow recover in value? That is just not going to happen. These sub-prime loans were NEVER worth what they were valued at, so they will certainly never "recover" to that level.

The only way the bank balance sheets can "recover" to a point where the capital markets will once again lend to them and get them off of the Fed's dole, is by either getting new capital from investors (some of which has happened, but I am pretty sure not anywhere near enough to make the banking sector's balance sheets healthy) or by the US Government taking the toxic assets off their hands at above market values.

In the case of the latter - which is what the TARP program was supposed to do - this is just another form of subsidy.

So the upshot is: Why SHOULDN'T we object when banks are now paying huge bonuses, if their profits are basically from public subsidy?

But I resent we are in this situation in the first place. It was absolutely predictable as soon as we bought the notion of "too big to fail." If we bail out the banks, they will be dependent on taxpayer largesse to survive. And that puts us in the position of either accepting whatever the bank managers want to pay themselves for the "profit" they squeeze out of us taxpayers, or start regulating the salaries of the "private" sector.

Thanks a lot, Bush and Obama!