Meredith Whitney, Wall Street's top bank analyst, weighs in this morning with a warning shot at the bullish mania taking hold on Wall Street.

Her message: Keep your powder dry and your wits about you. We may be in for a downturn because consumers and small businesses are suffering from a lack of credit.

"We continue to worry about the 'unintended consequences' of restrained liquidity to the US engine room, consumers and small businesses," Whitney says.

You've seen the bulls trotting out their data-mined justifications that we are at the beginning of another bull market rally. All deserving of only one thing--a half-hearted golf clap.

Their talk brings to mind the notion that a person who sees absolutes in the data where others see nuances and shades of meaning is either a prophet or a quack. The quacks are in force now.

Financial engineering is transforming sows' ears into silk purses, as banks have pummeled accounting rulemakers into submission when it comes to letting them warehouse trillions of dollars in bad assets off the balance sheet in order to execute regulatory arbitrage.

Citigroup, for one, still has $1.5 tn in off balance sheet assets. Bank of America, Fannie Mae, Freddie Mac, General Electric, all have off balance sheet assets, too. By shoving them off balance sheet, they can avoid the hits to their earnings from negative mark to market pricing, and they don't have to put aside more funds in their capital cushions to backstop these potentially rotten assets.

Because you, taxpayers, are now the backstops to the banking system, as the government reconciles the banks' gross habits with your net income. And because the banks ran their shops recklessly, they can't lend now because they need to ramp up their capital cushions to take care of mindlessly imprudent bookkeeping during the bubble years.

I'll let Whitney take the floor now, her words are a must-read, precise and sharp insights that are measured like a pharmacist:

With the stock market up nearly 50% over the last six months, many investors are inclined to believe that the economy is improving and bank earnings will return to “normal” again over the medium term. 

We believe such optimism may be falsely held. 

 Yes, the panic stricken days of the Fall of 2008 are all but memories, however, we argue the core fundamentals have not and are not improving.  In fact, we argue that things are likely to get worse on Main Street if not on Wall Street. 

We argue that in addition to US consumers, small businesses not only are crucial to a US recovery, but unless things change dramatically for the better, small businesses will in fact stymie the US recovery due to prohibitive access to credit and capital.

Since the onset of the credit crisis over two years ago, available credit to consumers has contracted by trillions of dollars, and that phenomenon is all too well reflected in dismal consumer spending trends.  Equally worrisome are the trends in small business credit. 

After all, small businesses employ 50% of the nation's work force and account for 38% of the GDP.  Small business credit has contracted at one of the fastest paces of any lending category. 

It is clear, well-capitalized companies are continuing to access capital, however, most in fact prefer to not draw down lines. 

Those small businesses who are far less well-capitalized are having the toughest go of it accessing capital.  While our clients know our cautious thesis on the US consumer, we believe investors should pay additional attention to similar trends extant in the small business lending market. 

According to the most recent Fed data, small business lending is down 3%, or $113B from peak levels, the first contraction since 1993. As loans to small businesses are contracting, another vital funding source for small businesses, credit card lines, is also shrinking.

Unused credit card lines are down 25%, or $1.2 trillion from peak levels. We have written extensively on such an impact to consumer spending, but we now are equally concerned by this trend's impact to small businesses. 

Credit cards are the most common source of liquidity to small businesses, used by 82% as a vital portion of their overall funding.  Thus it is of merit when 79% of small businesses say that credit card lending standards have tightened drastically and their access to credit lines has decreased materially.

Our outlook remains cautious on the overall US economy.  We believe that we are only in the early stages of the second half of this credit cycle.  We expect credit lines to continue to contract.  In fact, we expect credit card lines to be cut by an additional $1.5 T.  This includes not only the large lenders reducing exposure but also the shuttering of several major sub-prime lenders. 

Beginning in 4th quarter 2007, lenders began reducing available credit by zip code.  During the past four quarters, lenders have cut “inactive” accounts (whether or not the customer viewed the account as a liquidity vehicle or not). 

Currently, lenders are testing line management strategies which will lead to broadly lower available credit.  The next phase we believe will be line cuts as lenders race to preemptively protect themselves from regulatory changes associated with the CARD Act and UDAP. 

As we continue to base our research on the reconstruction of the component parts of liquidity trends and growth, it remains difficult to be constructive on core fundamental growth trends within the US. 

While the government is galvanized behind consumer protection, we continue to worry about the “unintended consequences” of restrained liquidity to the US engine room, consumers and small businesses.