Forgive me for sounding even crankier than usual, but the reason deception sells is that so many people line up for it.
The central bank released a so-called white paper today describing methods used by examiners from the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency to calculate the capital buffer the banks will require through 2011 under two economic scenarios.
“The anticipation over the white paper appears to be much ado about nothing,” said Josh Rosner, an analyst at independent research firm Graham Fisher & Co. in New York. “The most significant numbers provided by the Fed in the paper appear to be the page numbers.”
Financial stocks did well on the belief that most of the big banks would get clean bills of health. But that was the plan from the outset, to validate that the system was more or less OK so that if the poor chump taxpayer had to stump up more money, it could be positioned as due to completely unforeseen events (thanks to having put on very big blinkers) yet still a good risk.
The cheer seems a naive view. Citi is far from out of the woods, with a half trillion of foreign deposits, plus roughly $1 trillion in off balance sheet exposures (remember those SIVs, the watchword of late 2007?). Dislocation there would have far bigger ramifications.
The Financial Times, looking at more or less the same fact set, comes to less upbeat conclusions. Is this the result of being further from the spinmeisters?
From the Financial Times:
Some of the country’s biggest banks will be asked to raise more capital by US authorities following the completion of bank stress tests, senior Federal Reserve officials said on Friday.
A second, larger, group of leading banks will be asked to improve the quality of their capital by increasing their amount of common equity, the officials indicated.
Yves here. A surprisingly large number of market participants are of the view that the current rally is at least in part the result of market manipulation. I can’t recall ever seeing so much commentary to that effect. It amounts to an open secret. Even during the commodities run-up of last year, if you dared suggest there was a speculative component, you were treated as a conspiracy theorist. Now a fair number of commentators are making more aggressive claims, and they don’t seem terribly far out.
The latest sign of something out of whack is via Jesse, who tells us that insider sales are at high levels. When did that last happen? October 2007. Admittedly, not long ago, but nevertheless not a sign of confidence.
Now back to the FT. The officialdom has wanted banks to raise more equity since the Bear collapse. They fantasized that the banks would be able to get enough done in that recovery to stave off disaster. But as John Dizard pointed out at the time, the needs were so massive that (and he was serious) that central bankers would need to help conduct road shows.
That didn’t happen, needless to say. A year later, same problem, bank stocks much cheaper even post rally, so any equity raise more dilutive. And the powers that be have to hope all these banks that need more capital (admittedly reduced considerably thanks to the kindness of taxpayers) raise funds in this window.
The best of breed (for now) Goldman offering was a bit sloppy. Think all these banks, particularly with the stigma of a stress test forced raise, will get their deals done? The vast majority will be back at the government feed bucket, yet Mr. Market is acting as if everything is all for the best in this best of all possible worlds. Back to the FT:
Meanwhile, people familiar with the situation said regulators indicated that Citigroup might need more capital beyond a planned conversion of preferred shares into common stock that will give the government a 36 per cent shareholding.
If Citi has to raise more funds from the government, the authorities might force out Vikram Pandit, its chief executive. However, they added that no decision had been made and each bank had a week to discuss the results of the tests with regulators. Citi declined to comment.
While banks will be encouraged to raise the equity needed from the market, those unable to do so may have to ask the government to convert the preferred shares it holds in them into common equity. This could result in the US government ending up owning – at least temporarily – stakes in a number of the top US financial institutions.
Recall that banks (Citi et al.) that can’t raise the needed capital in six months then have to take more TARP funding. And recall further that the “stress” scenario is increasing looking like the mainstream forecast.
The Wall Street Journal has a similar report, with the addition than three of the 19 are to bolster their equity levels:
The identities of the banks, among the 19 institutions that were subjected to federal “stress tests,” couldn’t be learned. Analysts believe they likely include regional banks with large exposures to commercial real estate in the Midwest and Southeast. Three people familiar with the matter said at least three banks are in this position.
As we said, if the stress test fingers Fifth Third (clean reporting, well managed God-awful geographic footprint) and not Citi, you know the the priority is finding examples to validate its seriousness, and not really discovering real risks.
The problem with the tests is that the focus on the loan books (as reported by the AP) is missing the fact that loans decay more gracefully than bad structured debt or derivatives exposure. Outlier events will hit the big capital markets players far worse than traditional banks. But those scenarios have been deliberately omitted.
And per Bill Black, the emphasis on loans is a charade without inspection of the underlying loan files. And the number of inspectors was clearly insufficient for that to have happened.
The strategy is TinkerBell: if enough people applaud, belief alone will restore goners. That may work in theater, but I’m loath to rely on mere faith in matters of consequence. And as this blog has stressed, there does not seem to be a Plan B (the ideas of Paul Volcker and others not in the Summers/Geithner camp have been relegated to a policy gulag).