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Is the Fed Going to Go Easy on the Banks to Help Obama?

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We were more than a little surprised to read a Bloomberg story on March 10, which reported that the Federal Reserve was giving banks a hard time over its latest stress tests, particularly on the possible losses on consumer debt if the economy were to take a dive. The story indicated that if the Fed held tough, major banks would be restricted in making dividends and buying stock. This seemed to be quite a volte face from the Fed’s previous “give banks everything they ask for and then some” posture. But some Fed defenders argued, no really, once the banks were out of confidence crisis land, the regulators always planned to get tougher with them about building up their capital bases.

If today’s Bloomberg story is accurate, whatever resolve the central bank had was awfully short lived:

Wells Fargo & Co. (WFC) and Citigroup Inc. (C) may join banks unleashing more than $9 billion in dividend increases and share buybacks if they get passing grades this week on the Federal Reserve’s annual stress test.

Thirteen of the 19 largest U.S. lenders may say they’ll pay out $3.79 billion in extra dividends this year and buy $5.52 billion of additional shares, according to estimates of six analysts compiled by Bloomberg. That’s 30 percent more than they spent last year. San Francisco-based Wells Fargo probably will offer the biggest difference at a combined $4.16 billion, followed by Citigroup with $2.92 billion.

Now narrowly speaking, the two stories do not contradict each other. The later, cheerleading story, reflects analysts’ expectations, not any new information from the Fed. The earlier piece also noted that Mr. Market would be disappointed if the big banks (ex Bank of America) were restricted in their use of funds.

Now if we really believe that the Fed might have concerns about the solidity of bank balance sheets, which would be consistent with their super low interest rate largesse, why might they back off? Political scientist and leading expert in money in politics Tom Ferguson points out that any Republican presidential nominee, including Romney, is certain to be tougher on the Fed that Obama would be. He argues if the Fed proves to be generous to the banks, its motivation is likely to include the idea that the banks will start being more generous to Obama (and Bernanke) since the Fed continues to watch their backs.

The Fed has released its methodology for evaluating the banks (hat tip reader Deontos). It describes a much more adverse scenario than was included in the 2009 stress tests:

…a deep recession in the United States, significant declines in asset prices and increases in risk premia, and a slowdown in global economic activity… real GDP is assumed to contract sharply through late 2012, with the unemployment rate reaching a peak of just over 13 percent in mid-2013. The scenario assumes that U.S. equity prices fall by 50 percent from their Q3 2011 values through late 2012 and that U.S. house prices fall by more than 20 percent through the end of 2013. Foreign real GDP growth is also assumed to contract, with growth slowdowns in Europe and Asia in 2012.

Sounds like Lehman lite, and the more dire scenario is based, as the report indicates later, on concerns about the Eurozone. The Fed stresses that this is a scenario and not a forecast.

This in fact is pretty grim, and I would have trouble believing that the Fed could justify anything other than having the banks build up more in the way of capital buffers. As we’ve discussed repeatedly, the four biggest banks have residential mortgage second liens that based on the most recent data are valued at $369 billion. My understanding is that they are marked at between 80% and 90% of face value (JP Morgan may have written them down a bit more) when second lien paper is trading in the secondary market at 30 cents on the dollar. If you assume an average of 85% of face and it needs to be 30%, that $369 billion is really $130 billion, meaning you’d have a nearly $240 billion hit. And that’s just a realistic current mark, not taking into consideration the extra damage occurring in the new stress scenario.

In other words, if any of the big four banks are allowed to pay dividends or buy back stock this year, you should regard it as a bit of electioneering by the Fed. The banks have a long way to go before they are healthy, and the central bank knows even as it pretends not to know that for public relations purposes.

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31 comments

    1. charles sereno

      Just a trivial note on “austerity.” Yves’ title — “Is the Fed Going to Go Easy on the Banks to Help Obama?” — is translated into contemporary Hawaiian Pidgin as — “Da Fed, goin’ go easy on da banks fo’ help Obama? (11 words vs. 13)

  1. Vincent Vecchione

    Could you at least provide a link when you make a risible claim that ALL of the GOP candidates would be harder on the Fed than Obama. I’m not saying it’s not true, but it’s hard to believe that Romney would even support a Fed audit, and it seems unlikely that Gingrich or Santorum would actually want to put bonus-limiting strings on Fed disbursements.

    1. Mike S.

      When reading “Republicans will be tougher on the fed” I assumed Ferguson was speaking of the conventional wisdom on the Right over several decades: loose money brings unacceptable inflation.

      That is not exactly the same thing that’s being discussed here, re: capital requirments.

    2. Yves Smith Post author

      Come on, every Republican candidate ex Romney has dumped on the Fed. Santorum and Gingrich have trashed talked the bailouts too. The only one who has been a bit coy is Romney and even he’s been awfully friendly to Ron Paul, as we noted in a cross post from Mark Ames.

      By contrast, Obama reappointed Bernanke despite his colossal failure AND whipped personally to get the reappointment passed.

      1. Vincent Vecchione

        They’ve all dumped on the Fed, but there’s no evidence that they’ll be insisting on stronger capital requirements for the big banks, as opposed to even more regulatory forbearance. In fact, I think it’s hard to suggest with a straight face that the GOP candidates would refrain from attacking Obama and the Fed as Socialists, if they actually did insist on reserve requirements (not that this excuses the administration/Fed). Conservative posturing toward populism doesn’t actually lead to populist policies. It’s generally just a cover for even worse Libertarianism and Crony Capitalism. Besides, Gingrich and Santorum were both huge Greenspan fans. The anti-Bernanke dance isn’t substantive, it’s just scapegoating. What we need is to re-assert political sovereignty and transparency at the Fed, not blame the entire economic crisis on one person and change the deck chairs on the Titanic.

        1. C

          I have to agree in part. While they have dumped on the FED my sense is that Gingrich and Ron Paul would rather do without it entirely (a-la Mieses) and let “the market” take care of this rather than impose any additional regulation.

          Santorum will criticize it but I don’t sense that he cares much. When he was Senator he would vote with the party on financial issues. He was only interested when the culture wars were involved. Based upon that I expect he would support or at least sign legislation to “streamline” things but probably not rock the boat too much by getting rid of things.

          Romney, on the other hand, made his money on a Wall Street that was supported by the FED. I doubt he’d kill the money printers. Rather he would try to transform them back to a shop that supports the banks not the people and, if Wall St. needs another bailout, he’d listen.

          I agree they’ve all been beating up on the FED but it’s an easy target.

      2. rjs

        it’s still a stretch…the Fed goes easy on the banks because the Fed goes easy on the banks, not necessarily for ulterior political motives…

  2. Min

    Doesn’t the Fed have a traditional Republican bias during election years?Or is it different this time? ;)

    1. scraping_by

      Because of the faux populism that stinks up most R campaigning, they’ll have to Do Something that looks like reining in the Fed. Think Apache Dance rather than Apache raid.

      Because of Barry’s faux scientifism, he can get by claiming it’s all above the heads of nonspecialists. And if that doesn’t work, he’ll just play the race card.

    2. Yves Smith Post author

      No, Bush I has said he thought he lost in 1992 because Greenspan cut rates 6 months too late. By contrast, during the Clinton years Greenspan instiutionalized the Greenspan put, and the perception of support to the stock market no doubt worked to goose market averages and helped Clinton.

      1. chris m

        But let’s not forget how Arthur Burns allowed inflation to take off rather than raise rates and endanger Nixon’s re-election. And ever since the right has been flaming LBJ’s Great Society for the inflation actually caused by Republicans.

      2. nonclassical

        hmmnnn….I felt Perot split the vote, giving election to Clinton…In a way (I remember) we faced economic problems then-Como was interviewed on Armed Forces radio Europe, and stated Clinton would win, as he had most $$$$ backing…though Tsongas and Paul Simon had won first two primaries.

        The Greenspan factor I thought caused Clinton administration to look better than they were-Stiglitz’ book makes mention of fortuitous timing-positioning.
        I don’t believe Clinton was any economic guru…look at the mess he made of
        deregulatory legislation, admittedly at the behest of Texas repubLIEcon Senator
        Phil Gramm..and NAFTA was a disaster that keeps on giving, just as Perot foretold…

        1. different clue

          I keep seeing arguments on behalf of NAFTA from un-reconstructed Clintophiles. Is there any site or any books which analyses the various impacts NAFTA had throughout the economies and societies of the three NAFTA countries? Have any job-quantity numbers and job-quality numbers been put together anywhere?

  3. Richard Wilson

    “The Federal Reserve was giving banks a hard time over its latest stress tests, particularly on the possible losses on consumer debt if the economy were to take a dive….etc.”

    I’m confused.

    I thought the big banks >ARE< the Fed.

    The big private banks own most or all of the shares in Fed member banks and regional banks, yes? If that is true, then to think that the Fed is somehow different from the big private banks that own it is to maintain the delusion that there is some government or quasi-government body that has power over the big private banks.

    There is only one power in this nation: the Fed (i.e. the big private banks).

    I’m sorry if this undermines a lot of useless chatter among people, but truth and reality often have that effect. My apologies.

  4. Woodrow Wilson

    “or buy back stock this year, you should regard it as a bit of electioneering by the Fed.” -

    Maybe OT, but IBM did it recently while they fired thousands, not a peep (and continues btw).

    If a bank does it, it’s different? What happened to BAC? They should be in a graveyard right now? Bloomberg just had a piece today at how banks made record profits on the bond markets. The 2nd leins, thanks to unicorn accounting practices, allow this shit to continue, who’s going to change that bullshit (FASB 157)?

    Let me know when Citizens decide to take matters into their own hands, until then, enjoy being pillaged. The Fed? Let me know when summary executions start for them and all these politicians that enable selling us out to allow this bullshit to continue.

    Democrats & Republicans are one-in-the-same, The Fed? What fucking world are they living in? Not one where they have to pay for food and fuel. Sure, CONgress Members may differ on social issues, but they are both part of the looting/absence Rule of Law problem. The Fed just needs this acadamia bullshit shoved back up their ass.

    Electioneering indeed.

  5. K. Williams

    “the four biggest banks have residential mortgage second liens that based on the most recent data are valued at $369 billion. My understanding is that they are marked at between 80% and 90% of face value (JP Morgan may have written them down a bit more) when second lien paper is trading in the secondary market at 30 cents on the dollar. If you assume an average of 85% of face and it needs to be 30%, that $369 billion is really $130 billion, meaning you’d have a nearly $240 billion hit”

    This number is absurd on the face of it. The majority (60%+) of second-liens are HELOCs, the vast majority of which in turn went to people who had either no mortgages or prime mortgages. The delinquency rate on HELOCs as of 3rd quarter 2011 was 6%. Closed-end second liens generally went to people with shakier credit, but they constitute a minority of second-lien loans, and their delinquency rate as of 3rd quarter 2011 was around 12%. There is simply no way you can run those numbers and end up with a valuation of the second-lien holdings of 30% of face value.

    It’s true, of course, that some people are continuing to pay their second-liens (generally, CES) while they’re delinquent on their mortgages. But this is often a financially rational thing to do, since no one’s second-lien loans are being modified, while not paying your mortgage is often your only hope of getting a mod for it. More to the point, it’s simply not true (though it’s often stated on this site) that principal mods on first-liens require second liens to be wiped out. That’s not true as a matter of law (second-lien loans in most states are personal recourse loans, which is another reason why it’s not surprising that people are paying them), nor as a matter of policy. In any case, there is simply no case to be made that the $369 billion’s true value is anything like $130 billion.

    1. Yves Smith Post author

      You’ve simply revealed you have only a superficial understanding or are deliberately choosing to obfuscate.

      Unlike first mortgages, banks can and are playing all sort of games to keep HELOCs looking current. And the % that is HELOCs is MUCH higher than 60%, it’s 85% per the most recent Y9 filings. And we’ve discussed this ad nauseum in earlier posts:

      1. They are putting them on negative amortization. The borrower is two payments late, the bank calls and says, “Send me anything” and as long as it arrives before day 89, they can treat the loan as performing.

      2. They up the credit line, so the borrower is paying from funds provided by the bank. The old saying is “A rolling loan gathers no loss.”

      We’ve discussed this at length in earlier posts, for instance:

      The result is that the banks report a much larger portion of their second liens are current than would actually be categorized as current if they were required to define current on a fully amortized basis. Moreover, they are not required to write down these loans, which are mostly held in their “held to maturity” books even when the first lien is defaulted or in a significant negative equity condition (remember, unless there is equity in the house, an uncured default on the first means foreclosure, which means the second is wiped out. One of the reasons bank foreclosure timelines have become so attenuated is to avoid taking losses on seconds). Not surprisingly, the supine OCC contends there is nothing it can should do, to force the banks to behave otherwise.

      Before you say, “Gee, is all this so unreasonable?” let’s contrast this conduct with how regulators treated small bank commercial second liens recently. Bank expert Josh Rosner tells us that during the height of the crisis, certain primary prudential regulators forced the other regulators to make sure that the community banks with large commercial exposures had to have those loans reappraised and written down those exposures to fair value. This took place even when the loans were held in the held to maturity books of the banks. Keep in mind that the accounting rules were that loans in these books did not have to be revalued unless there was a credit event (such as a delinquency). Even then, they would normally be required to test the loans to see if the impairment was temporary or whether a writedown was warranted. Yet even in cases when these loans were paying on a fully amortized basis, the regulators forced these small banks to write them down.

      http://www.nakedcapitalism.com/2012/02/more-on-the-role-of-second-liens-and-the-mortgage-settlement-as-stealth-bank-bailout.html

      As far as the “rationality” of defaulting on a first and not a second, are you crazy? The fact that you’d suggest that strongly suggests you have an agenda. First, even a refi on a first is recourse. Only purchase money mortgages, and even the ONLY in certain states are non-recourse. Second, despite the bank harrumphing, pursuing deficiency judgments is not all that common. If people have lost their homes, there is not more to get, and even if they are one of the minority that get pursued to scare the rest, they can run out the statute of limitations. It’s painful but viable.

      And the biggest lie in what you say is that defaulting on first and paying a second makes sense. Huh? Defaulting on a first assures a foreclosure. By contrast, it is widely reported that second lien holders are blocking mods on firsts. Defaulting on a second GREATLY IMPROVES the odds of a mod on the first, since the second lienholder would block it, particularly if it is current or is being made to look current.

  6. C

    Perhaps they are just doing things slowly. Consider this article:

    http://www.americanbanker.com/issues/177_49/chase-credit-cards-collections-occ-probe-linda-almonte-1047437-1.html?zkPrintable=1&nopagination=1

    Apparently the OCC is ready to start prosecuting Chase for suing credit card holders based upon false claims. Apparently this process involved attorneys signing affidavits without reviewing them (sound familiar?)

    Of course in this case all the hard work of making the case was done by a whistleblower.

    1. Yves Smith Post author

      I have a story up on this. This is the OCC, not the Fed, so they are two unrelated actions.

  7. Conscience of a Conservative

    The banks 2nd lien loans will be worht a great dal more after the banks write-down the 1st liens held by investors. Maybe they know somethin?

  8. b.

    Every time I read John Hussman’s meticulous explanations of the analysis he applies to investments, I wonder whether it all comes to naught because of some simple rules of thumb, such as “the crash will not happen until after the election”.

    Of course, that only works as long as the Powers That Be Cursed actually have the “leverage” to successfully manipulate. I don’t think dot.com (Bush) or 2008 (McCain) was desireable for the PTB-C, there is a limit to how far the can can be kicked.

    Is there such a thing as corruption-informed investment funds? PIMCO comes to mind…

  9. Liberty Street

    Great article. One would hope the Fed would have the courage to do the math as laid out here on 2nd liens and tell the banks to hold on to their capital. With Europe and China slowing down and oil prices squeezing consumers’ wallets we certainly have a good recipe for recession.

    But the Fed hasn’t had the courage to go toe to toe with banks and other powerful interests since Paul Volcker knocked out inflation in the early 80′s – a story we lay out in “Money For Nothing” (www.MoneyForNothingTheMovie.org) – our upcoming documentary on the history of the Fed that includes exclusive interviews with Volcker himself, as well as people like Jim Grant and Jeremy Grantham and current and former Fed heads like Janet Yellen, Alan Blinder, Charles Plosser, Tom Hoenig, Jeff Lacker and many others.

    Is the Fed finally ready to be the “grown up” and make wise, long-term decisions that might sting a bit in the short term, as we all wish they’d done in 2002-2005? Or will it continue to let the big financials “scream for ice cream” and have their cake and eat it too?

    Stay tuned…

  10. Tony Frank

    This question was clearly answered today. The lackey fed did just what was expected of them by the financial mafia. These fed incompetents should tried for treason against humanity.

  11. Fiver

    The “Banks Pass Stress Tests” story was worth about $100 billion in paper equities gains alone even though Citi was cited as undercapitalized – and who wouldn’t be with a $1 trillion in off-balance sheet garbola. Yet it only took a modest hit, while other entities with similarly bogus off-balance sheet creative accounting (Wells, BoA – who just off-loaded its enormous derivatives positions on the FDIC – JPM, and MS and others all cashed in.

    The Admin and Fed are convinced they are on the right track, and have cobbled together a story supportive of a theory of de-coupling from the global (from Europe/Asia) economy along with a break-out to the upside for the US banking system and various “markets’. So a number of banks were virtually re-captialized based on this little Fed announcement. How good of Ben and the other Dears to care!

    Actually I find these “stress tests” no more convincing than the round in May 2009. A 50% drop in bank equity value now vs 2008, and 20% drop in housing prices now, would for neither be as dangerous a burden as what was confronted in 2008 – the baseline is still far lower that it was in 2008.

    But what gets me about the “tests” is that in the scenarios, neither the Fed, nor other Government agencies/players have reasonable (or other) actions written into the “game”. In other words, regulators focus only on conditions that the LAST TIME led to a crisis, and ignore both other significant financial dangers or remedial actions taken once a “crisis” has already been triggered. It is simply assumed the Fed will be no better at heading off a crisis that catches it completely by surprise, just like last time – at least, that’s what they’d like people to believe.

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