This blog is a card carrying hater of the stress test farce of earlier this year, The Treasury said from the start that the purpose of the stress tests was to restore confidence and show that the 19 banks tested, which hold 70% of the nation’s deposits, were well capitalized, and then said more or less in the next breath that there was a framework in place to get them more equity should they happen to need it.
But this was in large measure a “don’t ask, don’t tell” exercise. They used the banks’ risk models, did no sampling of the underlying records, and the economic scenarios were too optimistic.
Gretchen Morgenson of the New York Times today reports on the latest analysis by Chris Whalen of Institutional Risk Analytics on a much larger universe of medium to small banks than covered by the stress tests (it exclude them since they haven’t yet reported to the FDIC) and find their performance has deteriorated further even a few short months than the levels suggested in the stress tests than anticipated. It’s not an apples and oranges comparison, maybe Macintosh versus Granny Smith, but it still indirectly confirms the skeptics’ take.
And the article misses a much bigger implication: that the banks that are hitting the wall will be going into weak hands. There are not enough strong banks left for there to be a lot of sound buyers, So many of these weekend specials are merely kicking the can down the road, although the folks at the Fed are acting like they have this one licked, per the reports on the Jackson Hole conference. If they can keep the shell game going long enough, and they can keep a steep yield curve, the banks will earn their way out. That worked in the early 1990s recession, when big banks were holding a lot of bad LBO loans, but the banks are in a deeper hole now, and a steep yield curve conflicts with other Fed objectives, namely not letting long rates get too high (pressures mortgage rates) and not creating inflation. They might be able to continue to pull this off for while, but the longer the game goes on, the more something is likely to give.
And with a limited and shrinking universe of sound buyers as losses rise faster than earnings come in (save maybe at the big capital markets players, who are benefiting from fat trading margins and likely some gamesmanship), near term things will get worse in bank land before they get better. We expect a Resolution Trust Corp. v. 2.0 in our future.
Bill Black comments via e-mail on the latest mergers of the weak into the less weak via a weekend special of the previous week, the acquisition of Colonial, a $25 billion bank, by BB&T, making the new bank the eighth largest in the US. Black sharply disagreed with a New York Times analysis of that deal, by Eric Dash, http://www.nytimes.com/2009/08/15/business/15bank.html?src=linkedin”>which noted:
Wall Street’s biggest banks may be roaring back to life, but trouble still lurks in corners of the financial industry that remain plagued by a legacy of bad investments….
Regulators simultaneously brokered a rapid sale of its branches and deposits to BB&T Corporation of North Carolina, a regional bank that has emerged from the financial crisis as one of the industry’s strongest players. The failure is expected to cost the Federal Deposit Insurance Corporation about $2.8 billion.
BB&T’s purchase of Colonial may be another indication that the financial markets are healing.
Another New York Times piece, by Andrew Martin, had depicted BB&T as a sound bank that grew via acquisitions.:
Over much of the last four decades, John A. Allison IV built BB&T from a local bank in North Carolina into a regional powerhouse that has weathered the economic crisis far better than many of its troubled rivals — largely by avoiding financial gimmickry.
The FDIC-assisted BB&T acquisition of Colonial is ironic and insane. The irony is that both banks have embraced the same fundamental strategy – massive growth via acquisition. Colonial engaged in an extraordinary number of acquisition
First, it is insane to allow banks that are too big to fail to grow, much less grow massively. This maximizes moral hazard, the elite banks’ political power, and the risks of regulatory capture. Banks that are too big too fail should not be allowed to grow and they should certainly not be allowed to grow through taxpayer subsidized acquisitions of other failed banks. Banks that are too big to fail pose systemic risks. They need to be shrunk and intensively regulated.
Second, it is particularly insane to allow BB&T to be the acquirer, though anyone relying on the New York Times’ analysis would think the opposite. (So, the subtext is the continuing failure of financial analysis by many prominent financial reporters.) Extreme growth is one of the primary warning signs in banking. Extreme growth through acquisitions is an additional warning sign because it creates extraordinary opportunities for accounting abuse through purchase accounting. Andrew Martin’s ode to BB&T misses this entirely.
BB&T appears to have been the only acquirer willing to purchase Colonial – even with substantial FDIC assistance. That indicates that Colonial was in awful shape and that the financial markets’ problems are not being recognized honestly for accounting purposes. The acquisition means that federal regulators have allowed a bank, already “too big to fail” has been allowed to continue to grow massively.
Now Morgenson give us another dose of reality:
Christopher Whalen, managing director at Institutional Risk Analytics, a research firm, has analyzed financial data from the second quarter of this year that almost 7,000 banks….
Mr. Whalen said his figures show more stress in the banking industry in the second quarter of 2009 than in the immediately previous periods…
Based on his preliminary review of individual bank reports, Mr. Whalen said the greater stress across the industry results from the large number of banks getting dinged by losses or charge-offs. The figures, Mr. Whalen said, call into question assumptions made by the government earlier this year, when it put major banks through “stress tests.”
In short, the tests may not have been tough enough.
“The stress tests said that through the two-year cycle, big banks had to have enough capital plus earnings to withstand a 9 percent loss rate,” Mr. Whalen said. “But what we’re seeing with the levels of stress in the industry is that we are there now and we are not at peak of cycle yet.”
It would be better if we were wrong, but the declaration of victory on the financial front may be premature.