Happy Stress Test Day

Well, huzzah, the stress tests are here, and good news, everything's OK, just a matter of $75 billion dollars and we're ready to roll, just a rounding error, really. I can see why everyone's so excited. After all, if you can come up with a solution to a capitalization problem that involves "get(ting) the government to pay them more than three times the market value of their stock," I don't think you'd have anything to worry about either. And of course, the more that investors consider the banks to be healthy, the more healthy they quantitatively are, in a sense.

So my best guess is that this is a quite deliberate effort (there are credible reports of active efforts to squeeze short sellers) to pump up the bank stocks to facilitate their fundraising. John Dizard had urged central banks sponsoring road shows nearly a year ago to help them raise the needed equity. I'd prefer an open sales effort to this mingling of hucksterism with supposed regulatory policy. And they have clearly been intermingled. Note how the prime objective of the stress tests has been above all to restore confidence. Huh? The most important aim should be to assess their condition so as to determine what if anything needs to be done. To subordinate proper regulatory action to reassuring "the markets" is backwards. If the public had faith in the integrity of the process, the need for a confidence exercise would vanish.

One problem for the banksters: the outliers. Several bigger banks do need a good degree of capital, and at least in the case of GMAC, a lot more capital, comparatively speaking.

The federal government has ordered the financing arm of General Motors to raise $13.1 billion in new capital to ensure the firm's stability in the face of heavy losses in mortgage and auto lending and costs related to taking over new loans for Chrysler dealers and customers, said sources familiar with talks between government and industry officials.

The sum is among the biggest required for any U.S. financial institution, and could prove difficult for GMAC to raise because of the limited nature of its business and poor quality of its loans. The firm has struggled in the past to raise money from private investors and has already received $5 billion in federal assistance. It is likely that the federal government would end up providing much, if not all, of the needed capital, but it remained unclear where that money would come from.

About $4 billion of the total would be needed to cover the cost of assuming Chrysler Financial's dealer and retail auto loans, said one senior financial industry executive.

As James Kwak notes, this means that GMAC has negative capital at the moment, which, um, means insolvency.

Some smart people at the Times' Room for Debate series give their thoughts. I basically consider this a sham based on rosy scenarios and grade-grubbed by the subjects, but as has been said, we lost the debate inside the White House, and they're going to do what they must to keep the banks afloat. I think we have to focus on this Pecora Commission idea that's passed both houses of Congress (some helpful background here), which can lay the groundwork for major regulatory reform, through investigation of what happened to create the crisis. Obviously this comes out of Congress, so who knows what kind of teeth it will have, and historically blue-ribbon panels don't have much of a track record, but take a look at the potential of this thing:

The Financial Markets Inquiry Commission is empowered to hold hearings and to issue subpoenas either for witness testimony or documents and will have more than twenty substantive areas of focus, including:

the role of fraud and abuse in the financial sector
state and Federal regulatory enforcement
tax treatment of financial products
credit rating agencies
lending practices and securitization
corporate governance and executive compensation
Federal housing policy
derivatives
GSEs
short-selling

Additionally, the bill requires the commission to examine the role of fraud and abuse towards consumers in the mortgage sector, examine the extent to which the legal and regulatory structure governing financial institutions creates the opportunity for financial institutions to engage in regulatory arbitrage, examine the role of credit default swaps and the impact of financial institutions that are “too big to fail” on market expectations, and examine the causes of major financial institutions that failed or were likely to fail without government assistance. The Commission will report their findings and conclusions to Congress by December 15, 2010 and is required to refer any person who may have violated U.S. law in relation to the financial crisis to the Attorney General (AG) or state AGs.

We can put people in jail. We can set the future. We can shrink the financial sector. And we can do it through this panel. Let's push for a real commission.