Stress Tests - Victory For The Oligarchs

Congratulations, everyone! We ended the banking crisis because the biggest banks only need $65 billion in new capital!

The findings, to be released Thursday by the Obama administration, suggest that the rescue money that Congress has already approved will be enough to fill the gaps. If so, the big bailouts for the banks may be over.

All of this assumes that the economy does not take another turn for the worse, which would result in even more losses at the banks — and the need for even more money to prop them up. But hopes that the tests will be a turning point in this financial crisis electrified Wall Street on Wednesday and some overseas markets the next day. Financial shares soared, lifting the broader American stock market to its highest level in four months. The Dow Jones industrial average rose 101.63, or 1.2 percent, to close at 8,512.28 Wednesday, while Japan's Nikkei index rose more than 4 percent by midday Thursday [...]

After news this week that Bank of America and Citigroup would be required to bolster their finances again, word came Wednesday that regulators had determined that Wells Fargo and GMAC, the deeply troubled financial arm of General Motors, would need to do so as well. But regulators decided that American Express, Capital One, Bank of New York Mellon, Goldman Sachs, JPMorgan Chase and MetLife would not need to take action. The official word is due at 5 p.m. Thursday.

So no great shakes, just $65 billion or so, which can easily be accomplished through the conversion of government preferred shares into common stock. And Bank of America, the bank in the biggest trouble, may only be in the situation they're in because they were forced to eat Merrill Lynch despite the negative impact on the firm. Good job on that one, Henry Paulson!

Kevin Drum is confused. It's not just that circumstances haven't changed, but hard data from economists around the world show the banks to be much worse off than the stress tests display.

All I can say at this point is that I'm baffled. If Geithner is right, then everything is fine and the banking system was never really in very big trouble. $65 billion is nothing. But if the IMF is right, American banks are nearly $300 billion short. If Nouriel Roubini is right, the shortfall might be even greater.

So who is right? I have no idea. "All Americans should be confident that these institutions are going to be viable institutions going forward," Geithner said tonight, and I sure hope that's the straight dope. But these discrepancies are simply too large to wave away. Somebody is way, way off base, and I'd sure like to know who it is.

We actually know this already. The stress tests were simply not that stressful. We can see that in the sentence in the Times beginning "All of this assumes that the economy does not take another turn for the worse." That's the POINT of a stress test! Regulators were supposed to look at how the banks would react to stress. Not to mention the fact that the banks lobbied for new results to the stress tests after the initial data were released.

Anyway, the Treasury announced that they would serve as a backstop for any bank that showed difficulty raising the necessary capital. So no stress! Simon Johnson and James Kwak argue that we've reached a place of co-dependency between the government and the banks.

Since February, however, the government has clearly communicated that it has no such intentions, for example in Geithner’s insistence that “the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.” Even as the capital shortfall numbers have leaked out over the past few days, the government has emphasized that no banks will actually be allowed to fail, or even be allowed to be put into a conservatorship; instead, they will first attempt to raise capital from the private sector, and failing that they can convert their TARP preferred stock into common stock. Even if this results in significant government ownership, there is no evidence that shareholders or creditors will be forced to take losses. As rfreud said in a comment here, “The stress tests results are confidence-building in that they signal the low likelihood of nationalization or seizure. Reform at the moment seems a distant prospect.”

In short, relationships between the government and the large banks have never been closer, with large amounts of money flowing in one direction, and complete co-dependency going in both directions. Those relationships are not entirely friendly, which is not surprising. In any crisis when public resources are called on to bail out the private sector, not all of the oligarchs will survive; Bear Stearns and Lehman have already vanished. But the winners - which should include Jamie Dimon of JPMorgan Chase and Lloyd Blankfein of Goldman - will emerge even more powerful and influential than before.

In rejecting “nationalization” (regulatory takeover and conservatorship), the government has not ensured a private, properly functioning banking system. Instead, it has muddled into a broken-down, undercapitalized system that is nominally in private hands, but is able to tap the state for apparently limitless support. And to date, that support has flowed on one-sided terms, with the taxpayer accepting downside risk but limited upside potential. No wonder bank shareholders are comfortable with this outcome.

Not only that, but the recent consolidation due to those banks and investment firms that failed has led to higher market shares for those that survived. All that cheap money from the government means higher profit margins on the back end. The banks are comfortable with this approach - they don't have to care about their overall health, they retain their power with the government, and they collect a nice bonus at the end of the year.

If that's success, well, I'd hate to see failure.