Stress Relief

May 7th, 2009 by Phil Mattera

dont_worry_clockTreasury Secretary Timothy Geithner kicked off his big day with the publication of an op-ed in the New York Times asserting that the Obama Administration has brought a “forceful response” to the “damaged financial system” it faced upon taking office. “We chose a strategy to lift the fog of uncertainty over bank balance sheets,” he added, and “help ensure that the major banks, individually and collectively, had the capital to continue lending even in a worse than expected recession.”

Then why does the announcement of the results of the stress tests applied to 19 large financial institutions by federal banking regulators seem to create an even denser fog of confusion? You only had to look at the differences between the front-page headlines in the Washington Post and the Wall Street Journal to see the absence of a coherent story line from Geithner, Federal Reserve Chairman Ben Bernanke and other top officials.

BANKS NEED AT LEAST $65 BILLION IN CAPITAL blared the Journal in reporting the somewhat inaccurate information that had been leaked to it, while the Post presented its leaks with a more upbeat STRESS TEST FINDS STRENGTH IN BANKS. Following the release of the actual results late Thursday, the Post website was going with STRESS TESTS FIND BANKS NEED $75B IN EQUITY, while the Journal cranked up the alarm level with FED SEES UP TO $599 BILLION IN LOSSES.

The divergence in headlines reflects the contradictory messages that the Treasury and the Fed began feeding the public last fall and that have continued under the new administration. We’ve been whipsawed between the idea that there was a pressing banking crisis that required urgent aid from taxpayers and the notion that things were not so bad as to justify a federal takeover of the ailing institutions.

Bernanke continued the equivocation with his statement: “The results released today should provide considerable comfort to investors and the public. The examiners found that nearly all the banks that were evaluated have enough Tier 1 capital to absorb the higher losses envisioned under the hypothetical adverse scenario. Roughly half the firms, though, need to enhance their capital structure to put greater emphasis on common equity, which provides institutions the best protection during periods of stress.”

Given that the report tries hard to make the “adverse scenario” against which the banks were tested seem like a remote possibility, it is significant that nine of the institutions were deemed to have sufficient capital for such an eventuality. Ten did not. Bank of America is said to require an additional $33.9 billion in capital, Wells Fargo $13.7 billion, GMAC $11.5 billion, Citibank $5.5 billion and Morgan Stanley $1.8 billion. Five regional banks need to raise a total of $8.2 billion. These numbers suggest substantial relative weakness, yet Bernanke counsels us to feel comfortable, and many mainstream observers seem inclined to take that advice.

Geithner and Bernanke’s “don’t worry, be happy” approach seems designed to lull the financial markets while making the case for additional use of taxpayer funds to prop up some of the banks. It also serves to blunt any calls for nationalization.

If anything, the case for federal takeover of institutions such as Bank of America is stronger than ever in light of the stress test results. One way that BofA and others are expected to improve the quality of their balance sheets is to convert the preferred stock that the federal government received in exchange for its capital infusions into common stock, thus making the feds a more dominant shareholder.

Rather than seeing this as an opportunity to influence bank business practices, the feds will maintain a largely hands-off stance, according to the Financial Times. So we will continue to have a double standard between the activist approach adopted by the Obama Administration with regard to the auto industry and its unwillingness to challenge the banking elite, for whom the stress tests turned out to be a form of stress relief.

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