Throwing More Money Down A Sewer

When the stress tests were first released late last week, the official line was that most banks remain well-capitalized, but should hold a reserve above the regulatory requirements just in case. Then we heard that at least one unidentified bank would need more capital, but everything else is OK. Today, we're getting some names:

Regulators have told Bank of America Corp. and Citigroup Inc. that the banks may need to raise more capital based on early results of the government's so-called stress tests of lenders, according to people familiar with the situation.

The capital shortfall amounts to billions of dollars at Bank of America, based in Charlotte, N.C., people familiar with the bank said.

Executives at both banks are objecting to the preliminary findings, which emerged from the government's scrutiny of 19 large financial institutions. The two banks are planning to respond with detailed rebuttals, these people said, with Bank of America's appeal expected by Tuesday.

The findings suggest that government officials are using the stress tests to send a tough message to struggling banks. Bank of America and Citigroup have been the highest-profile problem children in recent months, but it is unlikely that they are the only banks the Federal Reserve has determined might need more capital.

I don't think the rebuttals will exactly help. Of course BofA and Citi will insist that they're well-positioned. They've been saying that since well before receiving $45 billion dollars a piece in government money. Which helped mitigate the worst effects, but did not solve the problem, as we can plainly see.

And then there's that ominous last line, that it's "unlikely" that they're the only banks shown to be in trouble by the stress tests. Regions Financial Corp., Fifth Third Bancorp and Wells Fargo & Co. are mentioned as possibles. We've gone from zero banks in trouble to a healthy portion of the 19 studied in a matter of days. There's also a wonderful line in there where government officials say "banks directed to raise more capital shouldn't be viewed as insolvent." Um, isn't that the purpose of the stress test and the very definition of an insolvent firm? Apparently not, says Edward Harrison.

"Instead, the capital is intended to cushion the banks against potential future losses under dire economic conditions. Federal officials say they won't allow any of the top 19 banks to fail.

Still, it is unclear how flexible the government will be about adjusting the results, especially as banks plead their cases individually. Banks have until the middle of this week to lodge their formal responses to the tests. Bankers expect that will set the stage for several days of intense negotiations between the banks and their examiners."

Ah, I see, it is all a sham.

It sounds a lot like a test where the student banks who just failed go to the teacher regulator with mommy and daddy bank lobbyists in tow to see if they can get their grades changed higher. See, the stress are just a scheme to make us think the Federal government is actually doing something about the under-capitalized banking system in the U.S.. In reality, the Obama Administration is just buying more time in order to let us grow our way out of this problem.

While Larry Summers does appear to now believe that financial industry growth has been outsized, he adamantly asserts that the stress tests were designed to get the banks the capital they need, not to reveal their essential insolvency. No bank will be able to recapitalize entirely with private funds. This imagining of the stress tests is simply a recipe for more government largesse. While we may be on the right track to putting in the proper amount of sand in the gears to ensure this never happens again, I'm extremely troubled by the way out being seen as feeding the giant maw of the banks over and over and over again.