Bank Stress Testing: Less Than Meets the Eye

We are supposed to be impressed with the speed and scale of government action on the bank front. As reported in the New York Times:

Nearly 100 federal banking regulators descended on Citigroup in New York on Wednesday morning. Dozens more fanned out through Bank of America, JPMorgan Chase and other big banks across the nation…

Details are scant. But exams for 18 or so of the biggest banks are set to begin immediately, and the first results could arrive within weeks. They are not expected to be made public for every institution. Regulators were also discussing whether to apply the stress test to small and midsize banks, according to an administration official.

This strikes me as grossly inadequate. I’ve had big banks as clients (including the then Citibank) and know what it is like to work with internal client data. It often takes a fair bit of digging and rectification to put what you’d think would be simple analyses together.

In the early 1990s, when Citi almost went under, it had 160 bank examiners working SOLELY on its commercial real estate portfolio (Citi has a lot of junior debt against buildings that turned out to be see-throughs).

I would welcome reader input (especially from bank examiners and accountants), but it is pretty clear 100 people and a few weeks (or even a few months) is grossly inadequate for a bank the size and complexity of a Citigroup. Citi has operations in over 100 countries. All 100 examiners can do is make queries along narrow lines, and work with the data presented. This scale of operation won’t allow for any verification or recasting of data. There isn’t remotely enough manpower.

And do you think these examiners are in any position to assess the risks of CDS, CDOs, swaps, foreign exchange exposures, Treasury operations, prime brokerage, to name just a few? I cant imagine US bank examiners have much competence in FX risk (Citi trades in a lot of exotic currencies, too), and that’s one of the easier to assess on the list above.

Now that isn’t to say they couldn’t develop this competence. In fact, Henry Kaufman (former chief economist of Salomon Brothers) has for some time argued that bank regulators around the world needed to form special groups with precisely these types of expertise to contend with the biggest, most sophisticated players. But they are not in place, and would easily take months to recruit and organize.

As a result, this is a garbage in, garbage out activity to placate the public and perhaps reassure investors. It would probably be fine for a strictly US bank which was a traditional retail and commercial lender (think a WaMu). But for the really big banks with capital markets operations, this is a joke. And those firms have and will continue to be the biggest recipients of the government dole.

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  1. doc holiday

    Re: Nearly 100 federal banking regulators descended on Citigroup..


    Is this like a vacation package for inept clowns @ Citi? I was wondering what happened to bank examiners lately, because I had this weird recent flashback from It’s A Wonderful Life and recalled that one of the main drivers in that flick (then) was the threat of an examiner looking for accountability; but what happened to those people anyway, where have they been? I guess I should read the post and shut my yap… sorry. This does makes me think of Colony Collapse Disorder also, but that may be off topic too… hmmmm

  2. alexblack

    In my fantasy, the 100 federal banking regulators descending upon Citi are actually a larger version of “Ocean’s Eleven”. Citi is giggling as they hide all their toxic assets from these “beauracratic rubes”, as the “regulators” are actually stuffing everything they can find that has value into duffel bags and disappearing into the night.

    Then the next week, Citi gets a call informing them that Obama’s Stress Test team will be arriving in a few days…..

  3. Richard Kline

    If the goal is to get a real evaluation of a behemoth like C, then no 100 sharp pencilholders won’t will in the blank. If the goal is to get a broad black hole/whirling galaxy pass/fail figure, 100 horn-rimmed types might do that in a fortnight or so. If the goal is to phoney up a number that can be flashed past Congresscravens and the public, then three pizza delivery boys and an Albanian cab driver could do that. I think the last goal is Timmy G’s intent, since the last thing he wants to find—the very last—are problems so large that a Major Player must be nationalized. Thus, to me this is a paperhanger’s plan: disappear the problem, then hand over the invoice. You know who gets the bill.

  4. Anonymous

    Voltaire’s “History is a lie commonly agreed upon (sic)” is maybe outdated. I would think that it is more appropriate now to say that history is a lie that is well paid for.

  5. esb

    From the beginning of this crisis or mess or implosion or whatever the hell you choose to call it (15July2007) the “powers that be” have continuously attempted to address it by running one con after another after another after another.


    The answer is patent.

    The 1000 or so families with (former) 100+ million dollar net worths have lost half of that wealth and they (through the intermediation of their servants in the Federal Government) are attempting to lay off that hit on the remainder of the population.

    This is the stuff of which revolutions should be made.

  6. Anonymous

    These type of pass the turd to the taxpayer games can only continue for so long. Since the problem is too big to bail at some point Obama will have to decide if he wants to be a one term President that hands over a boatload of cash to Wall Street or level with the people about the depths of the problem and get Wall Street to take their fair share of losses.

    With blogs like this its only a matter of time before some MSM reporter decides to be the next Woodward & Bernstein.

  7. Mathias

    It’s not even clear to me what kind of examining they will do.

    “Regulators were also discussing whether to apply the stress test to small and midsize banks, according to an administration official.”

    sounds a lot like doing stress tests with given valuation tools along the lines of “what do you get if you change … to … ?” to me. I hope I’m wrong though.

    Also I don’t see how 100 regulators are enough. Maybe to make sure that at least the business areas they are familiar with are sound?

  8. DoctoRx

    This post by Yves and the comments continue to support the Nassim Taleb idea that basic depository functions should be performed by simple, gov’t-owned banks (I prefer the regulated utility model) that are plain vanilla. The financial gambling can be done by lightly-regulated entities that KNOW they will not be bailed out and will be watched carefully to ensure they are not systemically important.

    As perhaps the most successful options trader in history, his opinion on derivatives is important as well: he says that A) he still does not fully understand options and B) believes that all derivatives other than options should be banned.

    For sure CDS between two parties neither of which has a direct interest in the loan should be banned. The way it is now, one of those parties has a financial interest in the bankruptcy of the borrower and can work to see that bankruptcy occur.

  9. Anonymous

    “As perhaps the most successful options trader in history, his [Taleb]opinion on derivatives is important as well…”

    Huh? Why the unnecessary rhetorical flourish? Taleb did ok, nothing special, which is why he left the game and became a writing/talking head. To his credit he understood the value of being ‘long gamma’ instead of chronically short it. Little more.

  10. Anonymous

    Those banks all have models and the regulators just have to sit down with those people and change some assumptions. Then check the results for reasonableness. Bang! They fail! Done it before myself.

  11. Markel

    esb, got a source for that? Time for a Madame DeFarge web site that lets the public know who the plutocrats really are. Like the 18 families who paid for the entire “death tax” scam.

    Back to the stress test: The simple fact that Timmay has, to this day, not announced or figured out any mechanism for valuing L3 assets means that the stress testers will not be valuing L3 assets. So what is the point?

  12. Anonymous

    If Citi understands their balance sheet then there is hope. My sinking feeling since last Summer is that Citi (and a few others), don’t understand themselves. So, I doubt 1000 T-men could ferret it out in a reasonable period of time.

    However, the T-men can ask Citi questions. And if Citi lies, that is a Federal offense. When Citi then crashes, we will have the perp walks on the news that seem to bring closure to these kinds of things.

  13. Markel

    I think there are two reasons why Timmeh may want to whitewash rather than fix the banks.

    First, fear of cascading failure. He was involved in the decision to let Lehman fail, and saw how that turned out. He is afraid letting one of the big six fail would lead to much worse systemic results, and doesn’t want to be the guy holding the gun. I think this a real motive.

    Second, though, I wonder whether Timmeh actually does know who would get hit. I don’t know about you, Yves, but I keep one eye on the crisis stories and another eye on the data showing a massive concentration of financial wealth in the U.S., the greatest since 1929. If we really saw who has the most to lose, if we could really look at all the books fully disclosed, would we discover that all of this effort is designed to keep just a few families rich?

  14. Kosta

    Your criticism is valid, 100 regulator are clearly insufficient to perform an accurate stress test, but what is the alternative? Outright nationalization of Citi would also involve federal regulators descending on the bank determining what kind of capital is needed, and again 100 would inadequate. How would that improve the situation?

    If one opts for the nationalization route, which is likely justified for Citi, how many other banks does one nationalize? BofA is also a likely candidate, does one immediately nationalize that bank as well? But if BofA is nationalized, will that not necessitate nationalizing JPM and WFC? After that, where does one stop? And how does one decide where to stop? Don’t the banks’ books have to be opened first?

    While the US gov’t likely has the resources to nationalize Citi (although the nationalization would take months to complete), its capacity is limited. Nationalizing all the big banks, and then providing support for the regional banks is quite the undertaking — could it be done successfully? And can it be done without first sending in federal banking regulators to first apply some sort of stress test?

    While your criticism of the report is valid on a narrow sense — 100 regulators seems inadequate, I think it is unfair on the broader scale. What else is the Federal gov’t supposed to do? There are no silver bullets here. The first step involves federal regulators opening the books of the bank.

  15. Anonymous

    so far all seem to be missing a basic question. why is a stress test already not being done by the bank’s risk management department. also, why have the regulators not asked for such tests to be performed before now. hence, this work is already being done or, if not, it has been a major risk management weakness that the regulators have failed to identify. this is just a sideshow so that tsy will have cover to shovel more money to the banks.

  16. Donlast

    There is one thing we can be thankful for and that is Bush is no longer Prez for certainly nothing he would have done or proposed would have had any credibility. The liberal Democrats would have gone berserk.

    Now, by his own admission we have a Prez who walks upon the water. He believes in spreading the wealth. He wants a government that is not big or small but just works. He is against pork. He appeals to all the instincts of those who struck out West and with their own hands and guts created America.

    But supposing all this is the pure audacity of dreams? What then if tax cheats like Timmy, his chosen Tres Sec, proves no better, even worse, than what went before. Suppose the stimulus proves to be a great con trick (Pour money into health care where unemployment is 3.8?).

    Is this not very flammable material for the Grande Illusion. Nowhere to hide any more. No more excuses. no Rummy, no Cheney, no Bush, just a very naked liberal Democrat party which proves to be just a coterie of puffed up self-preening windbags.

    So Mr Barack Hussein Obama has either to make it work or die, and take the Democrat Party with him. They think they are re-running FDR but it could be their nemesis.

  17. Anarchus (aka "whipping boy")

    I don’t want to be the whipping boy of the day, but somebody has to take the other side of the trade and be the voice of bureaucratic mindset here:

    1. Of all the banks, Citi is most irrevocably insolvent. You know it, I know it, most notably, even strange Timmy Geithner knows it.

    2. Look at it from Timmy’s perspective – Citi is bankrupt and needs to be propped up but the problem is so massive it’s probably not possible. Congress and the populace are not happy and nobody wants to be caught naked in front of a Congressional panel after a massive mistake, especially Timmy who is on the hot seat.

    3. WHERE, then, is the greater career risk for Geithner just focusing on Citibank? To maintain the fiction that it’s solvent and maybe/probably not be able to hold it together and then go in front of Congress next fall and say that, yes, my army of stress testers looked it over carefully and pronounced it solvent in March, but then the environment deteriorated and it became insolvent – risks looking very foolish, especially if Timmy’s stress testers pronounce Citi SOLVENT in March and then after reporting lousing 1Q earnings in early APRIL there’s a panic and Citi goes under.

    4. I say, Timmy is a bureaucrat and as much as he wants his big Robby Rubin payday on Wall Street post-retirement, on Citi at least he sacrifices a lamb in honor of his new career.

  18. Walter Zweifler, ASA

    The contrarian opportunity is huge right now. Transaction Price valuations offer reality – Most bankers rely on the delusion of discounted cash flow models. We have prepared a prototype credit default swap transaction price report and want to share our enthusiasm with others who agree that the ‘bankers are wearing no clothes’ 973 868 0294

  19. Anonymous

    Yves, the way to test a financial institution’s valuation of securities is to make them sell 5% of the position and then use that price, minus a haircut. That would work for everything except some loans. Of course, it’s a very rigorous test, which is, I imagine, why it’s not used much. But it should be.

  20. Anonymous

    Do the regulators get to partake in the FDIC pizza party if one of the investigated banks fails during this audit?

  21. Anonymous

    Doesn’t this laughable, redundant government “solution” just make clear (yet again) that the government can’t and won’t solve the problem? The Obama team hyped their Bailout plan to the high heavens before Tuesday, but they really offered a lot of nothing. All of you who slammed Bush and hope that Obama would bring the change we needed fundamentally miss the point – the government is even worse at this stuff than Citibank. Enough already! If they really think they are a viable business, lets see if they can do any business without government support. If not, let them go and move on.

  22. Kafka

    The problem is incredibly simple. The solution is incredibly painful. What to do? If you are a lying thieving Politico, you fund a bunch of econometric studies which tell the idiot public the problem is complicated but the geniuses know how to fix it. Of course at the same time, the thieving Politicos and their friends are laughing all the way to the bank. As an aside, the Politicos be smart, 80% of the public pays little in income taxes so spending other peoples money sounds like a good idea to the majority. How long can the Politico shell game continue, perhaps until the Politicos and their friends have sucked as much dough out of this country as possible, good plan dudes, I wish I was one of you but then again if there is a hell surely all the Politico thieves and their friends will burn.

  23. Anonymous

    More people would not necessarily improve the stress test. Obviously, it depends on the quality of the examiners. Laser precision is not necessary for this analysis. 10% valuation swag is enough to determine solvency. So, while we may disagree as to whether Mr. Geithner is seeking the truth with respect to solvency, it is possible to conduct the test with relatively few personnel.

  24. Kafka

    Oh yeah, there can be no doubt, all the majors are insolvent, who cares about a stress test. Jamie keep up all your lies, I am making a small fortune (for me) off your company. Gotta love all the fraudulent accounting gimmicks used by these banks. Of course accounting fraud only carries a stock so far, eventually the cash trail prevails, but stress test away dudes, every announcement that pops the market just creates more great shorting opportunities, thanks.

  25. Anonymous

    Good analysis, Yves. The article forgot to mention the rosy hues of the eyeglasses the regulators were wearing as they entered the buildings.

    My unexperienced banking opinion (applying only logic and reason with a sense of history) is that they know about 10 banks are insolvent and can’t continue in their present state, but nationalizing ten big banks worries them so much that they’re willing to settle on nationalizing the 2 with the simplest assets to deal with – the other 8 will get some form of injection-with-oversight and the rest will be handed a handful of confusing assets for a few pennies. We’re trying to save almost as much face as the Japanese.

  26. doc holiday

    I was laughing so hard at the army of examiner image last night, that I forgot to bring up the question, of how this stress testing process will go forward, i.e, is there a model or some process, some new software tool, like a secret weapon that has just been invented or patented, which was previously unavailable??

    We all have daily proof many times over that these models all failed and that no one understood or currently understands risk or comprehends accountability — including The FASB, Treasury, FDIC, SEC, FBI, DOL, etc, etc … which also includes state bank examiners, state auditors, state-based crooks that were all part of this collusion — so tell me — how are they all going to do a stress test after the fact, i.e, how do you do a safety test on a bridge that’s under water, huh, huh, yah wanna tell me punk?

    Thus goes back to restoring confidence in a real meaningful way and exposing fraud and then prosecuting people for lies and accounting fraud and then taking apart the mess designed by FASB and actually re-engineering the failed structure. This mess is well beyond Space Shuttle Challenger disaster where everyone collectively looked away at the flaws that were in front of them, and then as a group of corrupt retards, they all looked at the resulting explosion, which they brought about!

    FYI: The Rogers Commission found that NASA's organizational culture and decision-making processes had been a key contributing factor to the accident. NASA managers had known that contractor Morton Thiokol's design of the SRBs contained a potentially catastrophic flaw in the O-rings since 1977, but they failed to address it properly. They also disregarded warnings from engineers about the dangers of launching on such a cold day and had failed to adequately report these technical concerns to their superiors. The Rogers Commission offered NASA nine recommendations that were to be implemented before shuttle flights resumed.

    >> Screw the regulators, they are as corrupt and as inept as the fraudulent banksters and Obama Wonders. This is a failed society that has leadership unfit for a pig.

  27. Dave Raithel

    The themes of some of the comments pointed me back to the Paul Kedrowski article linked the other day:

    ” … as measured by asset size, the problem is chiefly in the six largest U.S. banks which collectively account for the preponderance of the banking industry balance sheet. Muddying the issue by saying that we would need to nationalize “thousands of banks” isn’t helpful.”

    Supposing that the goal is to fix the problem (and yes, one can reasonably doubt it), I’d think a massing of regulators on a single one of these six would do the most, if any good. But nationalization would have to be a viable possible outcome; which may induce the remaining five to put things into order. (Sam Johnson a la Gulag: Nothing so concentrates a capitalist mind as the prospect of dispossession in the morning …) I keep hearing, lately at places like Squawk Box and Market Report that “so called” toxic assets DO TRADE when parties find it mutually beneficial. This coheres with the earlier post re asset holders holding out for a better Government deal. So let’s consider taking that off the table, serially subject the largest six to merciless review, and THEN see what “the market” does.

  28. James B

    I wonder if the numbers of examiners are constrained by how many people they actually have. The FDIC slashed its workforce under Bush, and no one in the federal government has been much interested in examining anything for some time. Hiring and training people takes more time than the three weeks this administration has been in office. Maybe they’re just making due with what they’ve got?

  29. Bendal

    Obama and Geithner have to get this one right. If their investigators certify a bank as ‘safe’ and it later collapses or has to be nationalized, the public trust in ANYTHING the government says after that will be utterly zero. And why should they be trusted if that happens?

  30. Eric L. Prentis

    Progressives don’t advocate nationalizing US banks as the neocon Republicans will have you believe. We are saying that a small percentage of the 8,000 US banks are currently insolvent and before their managers do more grievous harm to the economy, these bankrupt banks should fall under temporary receivership, be reorganized and then resold to private interests. Stop taxing the poor to bailout the incompetent, rich, bonus-baby Wall Street bankers!

  31. Peripheral Visionary

    “More people would not necessarily improve the stress test. Obviously, it depends on the quality of the examiners. Laser precision is not necessary for this analysis. 10% valuation swag is enough to determine solvency. So, while we may disagree as to whether Mr. Geithner is seeking the truth with respect to solvency, it is possible to conduct the test with relatively few personnel.”

    Absolutely, spot on.

    This is not an attempt to value Citi or any other major bank to the penny. That’s an impossible task; this is, rather, a statistical effort that attempts to determine a valuation number within a reasonable margin of error. As such, the question is not whether a value can be reached, but what an acceptable margin of error is.

    As anybody who has worked in due diligence or compliance would know, an attempt at valuation does not start from scratch. The examiners will have Citi’s audited financial statements as well as their management reports, as well as prior examination reports and other government information sources, as starting points. The effort will be to determine the accuracy of the valuations being made by Citi. That does not involve checking each and every asset (an impossibly lengthy task), but rather spot checking data; start with the largest assets, mix in some randomly selected assets, look at unusual or exceptional assets. Again, the effort is not to get the total valuation down to within a penny, it’s to reduce the margin of error. Even some very basic spot-checking will quickly determine which areas have the most questionable valuations and which are the most solid (e.g., CDOs vs Treasuries).

    A hundred examiners, particularly experienced examiners, should be able to get the margin of error down to a reasonable range. Maybe not 0.01%, but quite possibly 1%; and if Citi is in bad enough shape, even a 10% margin of error may be sufficient. The more time and the more examiners they have the better, but a hundred examiners is likely sufficient, and a month is a tight timeline, but may be enough.

    I think it’s doable. And the question, of course, is what is the alternative? I’ve heard plenty of criticisms, but I don’t hear anybody suggesting expanding it to thousands of people and a six-month timeframe.

  32. Peripheral Visionary

    James B: My friend at the FDIC says they’ve been hiring as quickly as possible, but they are simply very short on resources. Even though I think 100 examiners may be sufficient for this examination, if there’s a reason why it’s not more, it’s because the FDIC just doesn’t have the manpower.

    At this point, the only alternative I can see would be bringing in private firms to assist in the valuations; and the most likely outcome would be the government overpaying for consultants who would proceed to use the insider information they would acquire in the process for personal profit. Obviously, I think that’s a mistake; the best approach for the government at this point is to prioritize and concentrate its resources on the largest and most troubled banks.

  33. doc holiday prayers Ltd


    You are getting on track there, in regard to how this mess needs to be thought about, i.e, what I think needs to happen, is that the wall street investment entities, like citi, jpm, bac, wfc, usb all have to be nationalized and then broken into fragmentary parts, i.e, good parts and toxic waste sludge.

    The good cash-flow components should be obtained by solvent regional banks, like, e.g, BANK OF NY MELLON … ok, to be honest, I’m having trouble finding an example of a regional-like bank, but let’s just say, something like a SunTrust or more realistically, like ahhh, well, I began this thinking that was an approach, but yikes: Fallout From Bad Loans Rocks Regional Bank Things are a bit hairy and we seem to be having a very bad case of the financial collywobbles!

    I still think, in theory, that Main Street banking is safe and they as a group remain solvent. Yah gottah think in terms of the roots of the internet in this situation, e.g, systemic case … and ahh, I'm having trouble with that example as well, but as I recall, the internet in the early days of DARPA & CERN was thought to be an attractive means for distributing information into a a wide network, for the main purpose of information storage security, which would be useful if a large scale attack or problem disabled a central core; that was sort of post cold war thinking, but the point I'm struggling to make here … is that the banking system is a massive network, and that the core mothership of wall street has been destroyed — however, the millions of fingers in the financial dike, I mean network or still viable and solvent and there is cash flow sloshing around in a vast network.

    What has to happen, is to treat this like a nuclear bomb hit wall street and yes, maybe even go back to 9/11 and see what plans were put into place in regard to a hit at the core of the financial world. That is the fuc-ing Plan that we should be looking at today, versus this screwed up political circus where no one has a clue what's going on.

    God forbid there would be another Katrina or some massive problem somewhere, but the thing that strikes me as I'm thinking about this, is wondering if we do have leadership in this country, and do we have plans in place for problems? There should be a plan somewhere that addresses a systemic crisis in the financial system, so where is that?

    Do we really have an entire Congress filled with retards that are clueless as to how to manage anything? For many years, maybe at least the last 40, people have assumed that people in Washington were corrupt, but there was a hint and whiff that some of the people there could manage, or at least appear to look like they had a clue — but now, we have a wide spectrum of idiots that have no plan, no leadership skills, no educational skills that are relevant, no experience and they all rely on uneducated hillbilly voters to help keep them in a loop of fraudulent bullshit.

    Where is The Planning (damn it)?

    How can we fix the friggn banking system if we don't understand it? How will a handful of half-trained, half-assed examiners be able to find the roots of Level 3 Assets and fraud, if they have no idea what their looking for? These boobs may as well be doing a search for porn and then use forensic magic to photoshop over this crisis.

    Dear God,

    Please, please, pleaze, help and give Yves the strength to keep up an attempt to help provide all those little stories that will eventually add up to the indictment and incarceration of all these people that have been involved in this collusion, which has destroyed the majority of loose fibers that have made up they country ……and


    P.S can you help with spell checking and grammer too?

  34. Anonymous

    Here’s a little stress test that needs to be circulated! However, SEC is as corrupt as wall street and the banks they are paid to protect!

    According to Section 308 of Sarbanes-Oxley, if the SEC — in any judicial or administrative action brought under SOX — obtains an order “requiring disgorgement against any person for a violation of such laws or the rules or regulations thereunder, or such person agrees in settlement of any such action to such disgorgement, and the Commission also obtains pursuant to such laws a civil penalty against such person, the amount of such civil penalty shall, on the motion or at the direction of the Commission, be added to and become part of the disgorgement fund for the benefit of the victims of such violation.”

  35. Yves Smith

    The issue is that both the existing valuations of assets and the risk models used at the big banks are suspect. If the risk models worked well, they never would have gotten themselves in this big a mess (bad incentives could push them to taking some undue risk, but not on this scale). Even Lloyd Blankfein in an FT comment said the risk models had clearly failed. There have been too many comments of the clearly ludicrous sort “oh, we had a series of 15 (or 25 sigma) events”. That’s statistically impossible. The universe isn’t old enough for even one 15 sigma event to have had any reasonable probability of happening. This is Taleb’s pet theme, as most readers know.

    And there is a fair bit of evidence saying that that the banks are carrying some (many?) assets at unrealistic marks.

    100 examiners are not going to be able to get to the bottom of either problem very quickly. How would they even know where to begin, for instance, at a Citi to ascertain which assets might be carried at rosy valuations?

    I have done and been on the receiving end of a lot of valuations. It can take quite a lot a scrutiny to find hidden assumptions that goose the valuation (in one case, for instance, it was four cells in the middle of a 60+ page model).

  36. Kosta

    Thank you for the the additional insight Yves, so it is understood that performing an accurate stress test with the assigned resources in the allotted time is not possible. What do you recommend that the administration do instead? Are there enough regulators to complete the job in the allotted time? Are there alternate approaches?

    Even if you go the nationalization route, the first step involves sending in regulators to open the books, and stress test the assets therein. I’m not sure how this opening move by Geithner can be improved.

  37. Elizabeth

    They should do a national callout for service from financial market people to join the “army” of examiners. I have personally volunteered to help – I consider this as service to my country. They need derivatives experts and traders to do valuations – not Fed regulars.

  38. FairEconomist

    It all depends on the examiners. If they just passively accept bank claims, obviously you won’t see much. If they go in, as I advocate, with their *own* models and apply them to the bank assets, a month of 100 examiners can certainly expose a profoundly insolvent bank. We’ve seen many on-line guesstimates pegging any of the majors as hopelessly insolvent. For example, what happens if there’s a hardnosed analysis of the comparatively simple 84 billion home equity portfolio at Wells Fargo?

  39. Yves Smith


    The bank examiners most certainly do not have their own models for any of the complex OTC market exposures. The Fed left risk management to the industry; the only approach they know is VaR, and as discussed many places, including here, that has considerable shortcomings. The OCC and FDIC would have had no reason to go here. The SEC should have take an interest, but didn’t.

    I have had top derivatives players as clients, and have a sense of what it takes to be competent. It requires an intuitive understanding of calculus to have a good handle of many of the derivative products (a corollary: the vast majority of clients did not understand the risks of what they were buying). How many bank examiners even have the math skills? Having taken calculus in high school or college does not suffice; you have to be using it on a regular basis. And then you have to have the product knowledge too.

  40. Yves Smith


    If you had read my post, my beef is not about the regulators’ ability to assess commercial banks with “traditional” retail and commercial bank assets. It’s the inability to assess the players with large capital markets operations. That’s where the big risks lie, and that is where the bulk of the TARP and rescue money has been going.

  41. cap vandal

    Citi is already in the process of splitting itself in two. I don't think there is much mystery about their financial condition.

    However, any major action along these lines will entail the first acknowledged loss from the treasury guarantees. And may require more money.

    The idea of trying to do something more systematic, orderly, and uniformly then the prior attempts is a good idea.

    Whatever is done needs to be done with some care. If you just wipe out the preferred, there will be the usual cascade of problems downstream. The debt needs to be treated reasonably.

    If you limit "troubled" to structured finance products and only count banks that have significant deposit bases (exclude GS and MS), then Citi has 1/3 to 2/3 of it.

    The bank could be split on an operational basis right now.

    The idea of doing anything that isn't a "one off/panic crisis intervention" is a huge improvement.

  42. doc holiday

    Re, Yves: "There have been too many comments of the clearly ludicrous sort "oh, we had a series of 15 (or 25 sigma) events". That's statistically impossible."

    > That reminds me of the Treasury Curve with its use of curve fitting to help ignore the reality of negative events and the fact that short term instruments can have negative yields, which is obviously total bullshit and we saw this happen, because The treasury falsifies data — and this is all related to the fact that non-marketable Treasury instruments are linked to fraudulent wall street securities … but enough there, or I'll explode and things will get very messy…

    > In other thoughts, it is well worth looking at this CRAP, IMHO:
    TITLE 18 > PART I > CHAPTER 73 > § 1505Prev | Next
    § 1505. Obstruction of proceedings before departments, agencies, and committees…05—-000- .html

    Whoever, with intent to avoid, evade, prevent, or obstruct compliance, in whole or in part, with any civil investigative demand duly and properly made under the Antitrust Civil Process Act, willfully withholds, misrepresents, removes from any place, conceals, covers up, destroys, mutilates, alters, or by other means falsifies any documentary material, answers to written interrogatories, or oral testimony, which is the subject of such demand; or attempts to do so or solicits another to do so; or
    Whoever corruptly, or by threats or force, or by any threatening letter or communication influences, obstructs, or impedes or endeavors to influence, obstruct, or impede the due and proper administration of the law under which any pending proceeding is being had before any department or agency of the United States, or the due and proper exercise of the power of inquiry under which any inquiry or investigation is being had by either House, or any committee of either House or any joint committee of the Congress—
    Shall be fined under this title, imprisoned not more than 5 years or, if the offense involves international or domestic terrorism (as defined in section 2331), imprisoned not more than 8 years, or both.

  43. doc holiday


    That is spot on and worth repeating!!

    "They should do a national callout for service from financial market people to join the "army" of examiners. I have personally volunteered to help – I consider this as service to my country. They need derivatives experts and traders to do valuations – not Fed regulars."

    >> I also think we need to have college kids that have good GPA's to join this effort, i.e, an accounting army. We need to give all these people in this army bountyhunter incentives to destroy corruption in the system, almost like using antibodies to kill viruses.

    The IRS has a bountyhunter program, but to make this work, we need good ol' fashioned Wild West sheriff-style justice, where the law goes in and nobody gets in the way, and if they do, yah shoot um, hang um or toss um in jail until you do your DD and get the facts, then hang um (after a fair trial).

  44. bondinvestor

    the stress test is a mirage. it's just a process that is being put in place to lead congress, the media, the bank industry and the american people to the endgame.

    the biggest clue that this is the case comes from the article in monday's times that quoted axelrod as saying that the WH wanted a package that was tougher on investors. he all but said they wanted to nationalize the banks.

    axelrod is obama's closest political confidant and the clear message here is that this is the geithner/summers plan. it's not the obama/volcker plan. if it doesn't show results quickly (ie, 3-5 months), i suspect we move on to plan B, which is a full blown swedish massage.

    the problem with implementing the swedish model now (as obama alluded to in a recent speech) is that nationalization is "inconsistent with our values". that is code for "there are powerful senators who *really* don't want to see the super-regional bank based in their state broken up."

    since obama has to deal with these senators for the next 4 years, he needs to set up a process to demonstrate to the entire world, beyond a shadow of a doubt, that these institutions are insolvent and there is no amount of private capital that is willing to plug the gap.

    that is what the stress test is all about. and it explains why the sector sold off hard on tuesday. rather than getting a handout from geithner & summers, investors realized all of a sudden that volcker and obama have put in place a trojan horse that will first lead to nationalization, then the atomization of the US financial system.

    i think if those of you who are advocates of the swedish model (and of a taleb/volcker-like financial system) wait a few months, you'll find that your patience will be rewarded.

    first you have to convince schumer, feinstein, boxer, whitehouse, shelby, frank, dodd, pelosi, etc that their beloved home town banks are insolvent and destined for the graveyard of history. a failed experiment in fascim, oligarchy and plutocracy.

    and the brilliance of obama is that by leaving in place lockhart, geithner, bernanke, warsh, bair, etc he can lay this squarely at the feet of the bush administration when the full extent of the damage is revealed.

  45. gordon

    It’s easy to say “nationalise” but if you want to keep a nationalised insolvent bank going you have to recapitalise it. Otherwise you aren’t nationalising, you’re liquidating.

    George Soros has estimated that $1.5 trillion will be needed to recapitalise the world’s insolvent banks, but there are lower estimates; nobody really knows. Maybe one of the objectives with the “stress test” is to find out for sure how much it would cost to recapitalise a really big bank. Then discussion of nationalisation could be put on a realistic basis.

    And I’d really like to know what the examiners might do when they fall across evidence of money laundering and tax evasion. I suspect that the major real reason why nationalisation is so unpopular in official circles is the fear that the criminal complicity of big international banks might come out. I notice that there is no guarantee that the results of the stress test will be public. Once again, this could be an experiment to see just how dirty big banks are.

  46. Anonymous

    I am a former national bank examiner and I’d argue strongly that the regulatory agencies are not equipped to deal with this issue. They simply do not have the internal manpower or expertise to run a stress test of any sort. The mission of the Fed/OCC/FDIC over the last few years has been one of risk review – they review the internal risk reports from management. They had and have no clue how to do this themselves (not that the banks did in retrospect). I agree with a previous post that what other option is there, although simply taking the banks over and reorganizing them is likely to be a simpler and more cost efficient model. We shouldn’t lose sight of the fact that BofA, Citi, etc. all had swarms of examiners on site for years. They did very little to prevent today’s mess. They are as culpable as the rating agencies in my view.

  47. Brad Stiritz

    to bondinvestor,

    sincerely, thanks for your perspective. i've been trying to make sense of all these puzzle pieces.. it's very interesting & helpful to see how you've connected the dots into a coherent & sensible picture, thanks. we'll see how things play out…

    p.s. to yves, sincere thanks to you as well for your blog & all the time & effort you put into it. best wishes :)

  48. Erich Riesenberg

    Perhaps some of the internal people could be fired and made external people, with some special legal responsibility thrown in.

  49. Mike Sankowski

    I pointed out at my blog that the complexity of banking accounting for these gigantic entities makes nationalization the only option for the biggest banks a few weeks back.

    The only way for this to work is to nationalize.

Comments are closed.