Expect more bailouts to come
WASHINGTON — The U.S. is expected to direct about 10 of the 19 banks undergoing government stress tests to boost their capital, according to several people familiar with the matter, a move that officials hope will quell fears about the solvency of the financial sector.
This sounds like an indirect way of saying that these banks are insolvent. Of course one would point out that raising capital does not necessarily imply insolvency especially since the stress tests are meant to test if the banks are capable of surviving under hypothetical worsening economic conditions. But this line of reasoning supposes that the stress tests are themselves an accurate simulation of how banks would perform under more adverse conditions. As noted earlier, the author of the stress tests hasn’t ruled out the federal government as a source of capital for these banks.
To make matters worse, it seems that people in the administration are all too willing to believe that Wall Street investors share the same rosy perspective as they do on the banks:
Administration officials believe many banks will be able to raise capital without tapping the Troubled Asset Relief Program’s remaining $109.6 billion. They’re optimistic the bulk of the money will come from private investors made more confident by the glut of information provided by the tests. Banks could sell assets and stakes in their companies, a move that could accomplish another government goal of shrinking some of the country’s largest banks.
Officials say banks that can’t tap private markets will be able to raise capital by agreeing to convert some of the government’s existing preferred shares into common equity, a move that would leave the government owning chunks of the nation’s largest banks.
Given how hedge funds on Wall Street have avoided concessions on Chrysler, is anyone willing to bet that the Treasury won’t be the main financier of these banks? It’s either that or a peculiar form of nationalisation; one which involves the government owning a majority stake in the company like they did in AIG (80% government-owned) but which does not involve the government too closely with the internal financial policy deliberations of the financial institution. We saw how that led to controversial bonuses paid out at AIG despite the government owning 80% of the company.
Results will be annouced on Thursday and hopes are dwindling that the announced results would be anything positive. Indeed at least one major ratings agency is preparing to downgrade the credit ratings of these banks:
The Fed plans to release the results of the stress tests on Thursday after U.S. stock markets close. Anticipating the test results, McGraw-Hill Cos.’ Standard & Poor’s Ratings Service unit put on watch for downgrade the credit ratings of 22 banks and one thrift.
I think most of us would be able to predict confidently that the annoucement will consist of at least 70% spin and 30% facts.
Update: Warren Buffett has criticised the stress tests flawed by one-size-fits-all mentality:
Warren Buffett, the revered investor, has criticised the Obama administration’s stress tests on the 19 largest US banks, arguing that a one-size-fits-all attempt to identify capital shortfalls was inappropriate.
Although Mr Buffett earlier commended the government handling of the financial crisis in general, the high-profile losses at Citigroup had distorted perceptions of smaller banks with different business models, he said yesterday, after the annual meeting on Saturday of Berkshire Hathaway, his insurance and investment conglomerate.
“That the most prominent bank in the world has needed assistance has framed the public’s view of the banking system. There’s nobody you can call to say ‘can you take over Citi this weekend?’,” he said.
Update 2: Bank of America told it needs to raise US$33.9 bn. More bailout, anyone?