naked capitalism

Now in fairness, the Administration is in uncharted waters in this economic crisis, and has launched a number of new programs to try to restore a measure of health. We’ve lambasted just about all the bank program as being based on the flawed premise that asset prices are temporarily distressed, rather than the recognition that a tremendous amount of credit was given to people who even at the time could not have realistically serviced the debt, plus another group that would be money good only if the economy kept running in high gear. But rather than accept the new reality, they are instead trying to prop up asset prices to restore status quo ante.

Aside from content, a second problem has been process. Despite Team Obama’s desire to be more consistent than the often improvisational Hank Paulson, they seem to be suffering from the same syndrome, of not being able to think enough moves ahead. For instance, Geithner first announced a plan to have a bank industry plan. That went over like a ton of lead bricks. Then he announced the public private partnership concept. Embarrasingly, the banks have started to buy up bad paper, making all too apparent the fact that the effort is merely to provide a huge, opaque subsidy to the banks, rather than an equity infusion (which economically is what this amounts to). But more equity infusions would lead to calls for more control or a resolution (let’s face it, if the banks need that much life support, they need to be put into receivership and restructured). But the Obama camp has decided we don’t do nationalization in America, as if Mussolini style corpocracy is a better option.

Then we had the change in eligibility for the legacy securities program for the PPIP. Recall the original plan was to have only four or five very large fund managers (the standards were written so that very few would qualify). That produced howls of protest, and now the program is being opened to smaller managers.

The latest change in direction is on the bank stress tests. We’ve been cynical about them from the get-go, seeing them as more PR than substance, since both the design of the tests and the manpower devoted to them guarantees that the examination will fall woefully short of what is needed. Although the analysis will be used to (presumably) make some of the 19 banks raise more capital, either on their own or from Uncle Sam, the main purpose was to assure taxpayers that their money was being spent wisely, the banks were not goners, that the Treasury does know what is going on and has procedures in place.

But no one gave any thought to what would happen with the results of the stress tests, Treasury had assumed it could get by with merely going through the process and assumed the results (as in which banks needed to raise dough) would speak for itself. Then the trial balloon was floated of releasing aggregate results, and that did not go over well either.

Now the New York Times reports that the Treasury has decided to reveal “some” stress details, its hand being forced by…..Goldman Sachs. The irony is rich, but if the markets take badly to some of the information revealed, this could produce a result exactly the reverse of what the Administration intended to achieve with this effort.

From the New York Times:

The Obama administration is drawing up plans to disclose the conditions of the 19 biggest banks in the country, according to senior administration officials, as it tries to restore confidence in the financial system without unnerving investors.

The administration has decided to reveal some sensitive details of the stress tests now being completed after concluding that keeping many of the findings secret could send investors fleeing from financial institutions rumored to be weakest.

Yves here. Do you notice the logic at work here, “rumored to be weakest”? Again, the powers that be believe this is all a matter of perception. It never seems to occur to them that some of the banks really might be in very bad shape.

In addtiion, I wonder if the willingness to reveal “some sensitive details” might open Treasury to reveal more via Freedom of Information Act requests. Unless information is competitively sensitive (and I don’t see how the results of these tests could be) I don’t see a compelling argument for withholding the findings, since the will be implicit in the capital raising requirements, which are to be revealed. Note that the Wall Street Journal suggests that there is an internal difference over how much to disclose:

It isn’t clear precisely what information the government might disclose. It remains possible the data won’t be specific to individual banks. But some within the administration believe a certain amount of information needs to be released in order to provide assurance about the validity and rigor of the assessments. In addition, these people also are concerned that the tests won’t be able to fulfill their basic function of shoring up confidence unless investors are able to see data for themselves.

Staff at the various regulatory agencies have been discussing the matter for several weeks and are expected to brief top regulators as soon as this week. One possible solution: Aggregating the data provided by the banks so the government could provide a broad snapshot of the banking industry’s health without disclosing firm-specific data.

Yves again. I thought aggregate data was Plan A, and we were past that. Aggregate data will not satisfy anyone. Back to the New York Times:

While all of the banks are expected to pass the tests, some are expected to be graded more highly than others. Officials have deliberately left murky just how much they intend to reveal — or to encourage the banks to reveal — about how well they would weather difficult economic conditions over the next two years….

Yves here. That means this is being negotiated. Wonder if the Times story was leaked to box the banks in and (as you will see later) blame it on Goldman. If so, this crowd would be playing a much smarter game than I have given them credit for (the “Goldman made us do it” part, the leak alone is a more predictable move). And this story was clearly planted. The Times reports it came from “senior officials”; as we noted, the Journal also has a story up. Back to the story:

The administration’s hand may have been forced in part by the investment firm Goldman Sachs, which successfully sold $5 billion in new stock on Tuesday and declared that it would use the proceeds and other private capital to repay the $10 billion it accepted from the government in October.

That money came from the Troubled Asset Relief Program, or TARP, and Goldman’s action was seen as a way of predisclosing to the markets the company’s confidence that it would pass its stress test with flying colors.

Goldman’s action has put pressure on other financial institutions to do the same or risk being judged in far worse shape by investors. The administration feared that details on healthier banks would inevitably leak out, leaving weaker banks exposed to speculation and damaging market rumors, possibly making any further bailouts more costly.

The Goldman move also puts pressure on the administration to decide what conditions will apply to institutions that return their bailout funds. It is unclear if Goldman, for example, will continue to be allowed to benefit from an indirect subsidy effectively worth billions of dollars from a federal government guarantee on its debt, a program the Federal Deposit Insurance Corporation adopted last fall when the credit markets froze and it was virtually impossible for companies to raise cash.

Yves here. By any logic (except the bank-friendly type operative at the Treasury), Goldman should be kept on TARP-esque terms as long as it is getting subsidies based on the assumption that it needs extraordinary government support, However, I peg the odds of Goldman being required to refinance the FDIC backed debt as about zero. Back to the story:

“The purpose of this program is to prevent panics, not cause them,” said one senior official involved in the stress tests who declined to speak on the record because the extent of the disclosures were still being debated. “And it’s becoming clearer that we and the banks are going to have to explain clearly where each bank falls in the spectrum.”…

Concern about the impact of the stress tests on the financial markets has been deep. Last week, the Federal Reserve, acting on behalf of itself and other regulators, sent e-mail messages to banks undergoing the stress tests, urging them to say nothing about the tests during the earnings season, including their capital needs or plans to return TARP money.

Yves here. So it looks like Goldman defied orders. Back to the piece:

Despite the regulators’ warning, there is evidence that some banks are trying to signal to the markets early that their quarterly results will look good — and, by implication, that investors should not worry about the tests.

Citigroup and Bank of America made positive statements about the current quarter weeks ago, and last week, John Stumpf, the chief executive of Wells Fargo, said the bank was in good shape and expected a $3 billion profit this quarter. The Wells Fargo statement appeared to frustrate some Treasury officials, and regulators clearly fear it will be more difficult for them to issue negative assessments of banks that have already proclaimed that they are in good shape.

Yves again. That comes pretty close to saying the Feds don’t buy Wells’ earnings release. That’s serious, and consistent with analyst views. It also shows how banks have become accustomed to pushing regulators around, when in fact a regulator can greatly increase capital requirements when warranted (and given all the dreck on these banks’ balance sheets, that would be in order in the normal course of events) and yank their license. And there are lesser tortures, like intrusive inspections. But that in turn requires staffing, and the industry has done a great job of pushing for less oversight, which has in turn lead to headcount cuts.

This may turn out to be a minor sideshow, but if it comes to a head when markets are rattled, we could see more serious fallout, as some warned the Journal:

The move to stop treating banks equally is sparking concern about the effect on specific institutions seen as weaker than peers. “You can create a run on a bank pretty quickly,” said Eugene Ludwig, chief executive of consulting firm Promontory Financial Group and a former Comptroller of the Currency.

Wayne Abernathy, executive vice president of financial institutions policy and regulator affairs at the American Bankers Association, said the government needs to provide information about the results but also protect examination data.

“I don’t think they can ignore the appetite they have created for this information,” Mr. Abernathy said. Having the government publicize some information would allow policy makers to control the message. “It’s what can we say that is meaningful while still protecting the quality of that exam data,” he said.

Mr. Ludwig cautioned that any information could give rise to mischief. “Bank exams are confidential for good reason,” he said. “Given the kind of confidential information they contain, there is always the possibility of misuse or misinterpretation.”

While Ludwig is likely correct, the Administration created this risk with an element of program design not stressed in these stories. Remember, a bank that fails the test is given a certain amount of time to raise equity, and if that fails, they have to take more TARP funding. Now pray tell, how is a bank going to raise capital except on hugely dilutive terms when it is evident that it did badly on the test? The revelation that a bank got a low score, more than the high level and not terribly revealing tidbits, will be the source of trouble.