We have been skeptical that the pending Treasury stress tests on banks, designed to ascertain their state of health, were inadequately staffed and therefore could not do the job properly. Our big concerns were that they had too few bodies to test financial data versus underlying documentation adequately (usually done on a sampling basis) and they lacked the expertise (and perhaps the mandate) to vet risk models (which we all know have performed impeccably over the last two years.
Is it a test if the results are pre-determined? Apparently Team Obama thinks so.
From CNBC (hat tip reader Early Withdrawal):
Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.”
Now consider this observation from a reader in comments:
I have a personal anecdote about Citi and the difficulty of spotting how bad their loans actually are. I’m involved with a $300 million condo-hotel development in the Caribbean. Citi has the whole loan (i.e., they didn’t securitize or otherwise sell participations in the loan). Even now, we expect the hotel needs at least another $100 million to finish construction and open (we are no longer under any delusions that more than a handful of buyers will close on the condo portion of the condo-hotel). So, in other words, Citi is $275M into this project, and it’s not certain that the completed hotel will even be worth the extra $100M required to complete and open. Hence, one might plausibly value this $275M loan at zero (i.e., a complete write off). I cannot imagine any stress test would uncover what a huge loss is on the way in the next 12 months. In fact, this loan has not even been pawned off to the nonperforming/distressed debt/workout section of Citi because the interest reserves make it “seem” like the loan is still performing, not to mention that completely out of date pro formas make it “seem” like (i) equity will come in to finish the project and (ii) condo sales will pay down a huge part of the principal once construction is complete. This scenario must be present in a large number of Citi loans, especially in their somewhat active foreign development divisions. Citi must be so far from solvent that it’s not even funny. Only hyperinflation in the dollar could ever make it possible for the borrowers to pay back some of these loans. I’d bet that the sooner we face reality on some of these loans and just halt future fundings, the less money the taxpayers are going to lose. As it is, it’s almost too late. Too bad for the US taxpayer.
This is merely one story, but there has been a fair bit of coverage in the business press as to how a lot of real estate development, particularly high end resort, is being mothballed or simply cancelled. So there are no doubt other deals like that at Citi and other US banks.
Commercial real estate is also only one of many many portfolios at Citi,. We noted earlier than when Citi was on the ropes in the early 1990s, 160 bank examiners went in to get a handle on Citi’s CRE book in Texas and the Southeast. Those alone were enough to put the bank at risk.
We now have 100 bank examiners reported to be at Citi to give a bill of health on a much bigger, more complex enterprise than the Citi of the early 1990s. Do you think this is a credible exercise?
Anonymous 
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This is old, but, maybe a few clues?
Bank Financial Strength Ratings: Update to Revised Global Methodology
Tangible Common Equity is defined as Common equity less the sum of goodwill and other identifiable intangibles.
Many respondents were concerned with our proposed use of a simple leverage ratio (Equity/Assets) for assessing Capital Adequacy, especially because it did not take into account risk-weighted assets (RWA) and could therefore penalize banks with a substantial volume of low-risk assets. Our initial rationale for including the simple leverage ratio was to incorporate one capital ratio that could easily accommodate those banks that do not disclose risk-weighted assets. However, after carefully taking into consideration these comments and the proposals made by some, we have changed the BFSR scorecard by replacing the simpleleverage ratio with the ratio Tangible Common Equity (TCE).
The new ratio captures the risk profile of banks’ assets (on- and off-balance sheet) as per Basel criteria which the former leverage ratio failed to address. Tangible Common Equity – nearly identical to the “core Tier 1” ratio reported by many European banks– will be adjusted to reflect Moody’s Basket Treatment for hybrid securities. For those banks that do not disclose risk-weighted assets we will estimate risk-weighted assets using broad balance sheet and off-balance sheet categories and standard risk weightings. These estimates will be compared to those of similar peers with disclosed risk-weighted assets as a check on their reasonability.
•We also received several comments questioning why the combined weighting for balance sheet-related sub-factors (capital, asset quality, and liquidity) was higher than the combined weighting on the profitability and efficiency sub-factors. The respondents felt this contradicted Moody’s normal approach of stressing the importance of stability and predictability of earnings. Other respondents mentioned that capital has historically been cited byMoody’s as a lagging indicator of credit worth, and wondered whether capital ratios should receive less weight inthe scorecard. The respondents are correct in that for banks with strong balance sheet ratios, much of Moody’s analysis is focused on the stability and predictability of earnings.However, the scorecard incorporates earnings stability and predictability into Franchise Value, and indeed indirectly into Risk-Positioning as well. Therefore, we believe thatoverall the scorecard continues to assign greater weight to earnings predictability and stability than to balance sheet ratios. And to the extent that the balance sheet ratios are weaker, they usually do play a larger role in Moody’s ratings decisions. For weaker institutions the role of capital has always been significant to Moody’s ratings. We therefore continue to believe that the relative weightings within the Financial Fundamentals section are appropriate. However, the changes to the relative weighting of Financial Fundamentals versus Qualitative Factors for banks in mature markets, as well as the changes to the maximum factor, both described above, will likely lower the overall impact of any particular financial ratio on the overall scorecard estimate.