This blog is a card carrying hater of the stress test farce of earlier this year, The Treasury said from the start that the purpose of the stress tests was to restore confidence and show that the 19 banks tested, which hold 70% of the nation’s deposits, were well capitalized, and then said more or less in the next breath that there was a framework in place to get them more equity should they happen to need it.
But this was in large measure a “don’t ask, don’t tell” exercise. They used the banks’ risk models, did no sampling of the underlying records, and the economic scenarios were too optimistic.
Gretchen Morgenson of the New York Times today reports on the latest analysis by Chris Whalen of Institutional Risk Analytics on a much larger universe of medium to small banks than covered by the stress tests (it exclude them since they haven’t yet reported to the FDIC) and find their performance has deteriorated further even a few short months than the levels suggested in the stress tests than anticipated. It’s not an apples and oranges comparison, maybe Macintosh versus Granny Smith, but it still indirectly confirms the skeptics’ take.
And the article misses a much bigger implication: that the banks that are hitting the wall will be going into weak hands. There are not enough strong banks left for there to be a lot of sound buyers, So many of these weekend specials are merely kicking the can down the road, although the folks at the Fed are acting like they have this one licked, per the reports on the Jackson Hole conference. If they can keep the shell game going long enough, and they can keep a steep yield curve, the banks will earn their way out. That worked in the early 1990s recession, when big banks were holding a lot of bad LBO loans, but the banks are in a deeper hole now, and a steep yield curve conflicts with other Fed objectives, namely not letting long rates get too high (pressures mortgage rates) and not creating inflation. They might be able to continue to pull this off for while, but the longer the game goes on, the more something is likely to give.
And with a limited and shrinking universe of sound buyers as losses rise faster than earnings come in (save maybe at the big capital markets players, who are benefiting from fat trading margins and likely some gamesmanship), near term things will get worse in bank land before they get better. We expect a Resolution Trust Corp. v. 2.0 in our future.
Bill Black comments via e-mail on the latest mergers of the weak into the less weak via a weekend special of the previous week, the acquisition of Colonial, a $25 billion bank, by BB&T, making the new bank the eighth largest in the US. Black sharply disagreed with a New York Times analysis of that deal, by Eric Dash, http://www.nytimes.com/2009/08/15/business/15bank.html?src=linkedin”>which noted:
Wall Street’s biggest banks may be roaring back to life, but trouble still lurks in corners of the financial industry that remain plagued by a legacy of bad investments….
Regulators simultaneously brokered a rapid sale of its branches and deposits to BB&T Corporation of North Carolina, a regional bank that has emerged from the financial crisis as one of the industry’s strongest players. The failure is expected to cost the Federal Deposit Insurance Corporation about $2.8 billion.
BB&T’s purchase of Colonial may be another indication that the financial markets are healing.
Another New York Times piece, by Andrew Martin, had depicted BB&T as a sound bank that grew via acquisitions.:
Over much of the last four decades, John A. Allison IV built BB&T from a local bank in North Carolina into a regional powerhouse that has weathered the economic crisis far better than many of its troubled rivals — largely by avoiding financial gimmickry.
Black’s comments:
The FDIC-assisted BB&T acquisition of Colonial is ironic and insane. The irony is that both banks have embraced the same fundamental strategy – massive growth via acquisition. Colonial engaged in an extraordinary number of acquisition
First, it is insane to allow banks that are too big to fail to grow, much less grow massively. This maximizes moral hazard, the elite banks’ political power, and the risks of regulatory capture. Banks that are too big too fail should not be allowed to grow and they should certainly not be allowed to grow through taxpayer subsidized acquisitions of other failed banks. Banks that are too big to fail pose systemic risks. They need to be shrunk and intensively regulated.
Second, it is particularly insane to allow BB&T to be the acquirer, though anyone relying on the New York Times’ analysis would think the opposite. (So, the subtext is the continuing failure of financial analysis by many prominent financial reporters.) Extreme growth is one of the primary warning signs in banking. Extreme growth through acquisitions is an additional warning sign because it creates extraordinary opportunities for accounting abuse through purchase accounting. Andrew Martin’s ode to BB&T misses this entirely.
BB&T appears to have been the only acquirer willing to purchase Colonial – even with substantial FDIC assistance. That indicates that Colonial was in awful shape and that the financial markets’ problems are not being recognized honestly for accounting purposes. The acquisition means that federal regulators have allowed a bank, already “too big to fail” has been allowed to continue to grow massively.
Now Morgenson give us another dose of reality:
Christopher Whalen, managing director at Institutional Risk Analytics, a research firm, has analyzed financial data from the second quarter of this year that almost 7,000 banks….
Mr. Whalen said his figures show more stress in the banking industry in the second quarter of 2009 than in the immediately previous periods…
Based on his preliminary review of individual bank reports, Mr. Whalen said the greater stress across the industry results from the large number of banks getting dinged by losses or charge-offs. The figures, Mr. Whalen said, call into question assumptions made by the government earlier this year, when it put major banks through “stress tests.”
In short, the tests may not have been tough enough.
“The stress tests said that through the two-year cycle, big banks had to have enough capital plus earnings to withstand a 9 percent loss rate,” Mr. Whalen said. “But what we’re seeing with the levels of stress in the industry is that we are there now and we are not at peak of cycle yet.”
It would be better if we were wrong, but the declaration of victory on the financial front may be premature.
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This doesn't help any…http://www.hellenicshippingnews.com/index.php?option=com_content&task=view&id=61550&Itemid=79
Clearly with institutions like Colonial, Corus, BankUnited and Guaranty the FDIC is just looking for a willing buyer to avoid a full takeover and liquidation. There is no way the FDIC would have the manpower. It would be better not to allow a bank like BB&T grow further, but no smaller bank could have swallowed Colonial.
It will be interesting to see how things work out, but I do not see RTC in the works. The FDIC seems more than happy to work with loss share agreements, which in essence replace the RTC but with the use of much less manpower.
-Stephen
Steve,
Yes, I may be too grim, and the powers that be have been favoring forbearance, which is not the best way out of a crisis (and we are now in denial with the continuing large interventions that the crisis is far from resolved).
I may have been reading too much of Veneroso's Mortgage Armageddon. Plus I am hearing FAS will be a huge deal, no one has focused on that yet, but I need to do my own spadework here.
«a steep yield curve conflicts with other Fed objectives, namely not letting long rates get too high (pressures mortgage rates) and not creating inflation.»
This may be ostensible objectives, but what are the priorities? And the Fed is not just the Fed, it is the operational arm of a set of political and business interest groups.
My impression is that those groups have decided long ago to solve the pension problem via accruing large (nominal) capital gains to property owners, and damn everybody else. This means that fighting inflation is a low priority, and mortgage rates are a larger priority, but not so large, as many property owners have already largely paid it off; except those which have remortgaged, and the number of these and their political weight is probably one of the biggest factors in what is going to happen.
As you and others have documented, these interest groups have resorted to creating what are in effect private taxes by manipulating interest rates in order to avoid overt fiscal maneuvers; and previously, the Greenspan Put and the Bernanke Swap have also been used to achieve fiscal policy goals indirectly.
Greenspan and others have recently stated very overtly and clearly that the goal of policy should be to create huge capital gains for wealthy property owners to restart "trickle down" in the economy.
So nothing new. and I expect those interest groups to keep their actions firmly focused on their main goals, which do not include fighting inflation, and perhaps not even that much on mortgage rates.
As to nothing new I think that commenter [bullbust] on EconomistsView summarized the plan very very clearly a while ago:
http://economistsview.typepad.com/economistsview/2008/02/why-bubbles-occ.html#c105213332
I read and enjoy the IRA but they have been offer the mark on banks. Anyone who has taken advice from Chris Whalen over the past 6 months has lost a lot of money or at least missed the chance to earn 500%+ returns on some of these (for example Bank of America).
Yes, bank balance sheets are a mess but he missed the most important factor. The Fed and government will do anything to keep these banks from failing. Bernanke stated as much right in front of Congress and yet Whalen went right on saying that these banks would be nationalized. Next time, bet on the guy with the printing press and power to set regulatory policy not the banking "expert" on the outside.
The Fed's ZIRP policy means lower deposit costs which allows for record NIM for banks. A couple years of this and they will replace all their lost capital with new earnings courtesy of savers who now get only 0.5% or less on deposits.
Banks simply earning their way out of this hole will take a long time:
Published: April 12 2009 18:05
LEX column
Financial Times
But the bigger issue for investors is whether banks’ new earnings potential can counteract the inevitability of further writedowns. That depends on forecasts for revenues and the extent, and timing, of losses. Oliver Wyman and Morgan Stanley have taken a stab at estimating the former. They reckon global wholesale banking revenues in 2010 will be about $220bn, helped by “volatility products” such as foreign exchange, fixed income, money markets and commodities.
Many, including the IMF, expect total global credit losses to approach $4,000bn as the economic slowdown means that more traditional forms of lending become toxic. Assuming banks account for three quarters of losses, and they have already torched $915bn, according to Bloomberg, that equates to 14-odd years of revenues (other things, such as capital ratios, being equal).
Yves,
You may have commented on this at the time but
discerning minds may have caught that prior to the announcement of the stress tests the Feds had already made requests for and received the majority of info from the banks.
NY Times (Feb 3, 2009!) : Nearly 100 federal banking regulators descended on Citigroup in New York on Wednesday morning. Dozens more fanned out through Bank of America, JPMorgan Chase and other big banks across the nation….Exams for 18 or so of the biggest banks are set to begin immediately, and the first results could arrive within weeks. They are not expected to be made public for every institution…Regulators plan to assess the potential losses a bank could face over the next two years, rather than the typical one year … They are also expected to look at banks’ exposure to derivatives and other assets normally carried off their balance sheets … Their assumptions will be guided on a “worst case” basis.
When the Stress tests were announced and the results drawn out for weeks (even though it only took Goldie a weekend to do theirs), an unnamed FDIC staffer summed it up best: "It's a sham," one source told The Post, describing the test as an "open-book, take-home exam" that doesn't actually work.
The stress tests were just an IQ test. Most of us received failing grades.
I am constantly surprised that more financial writers do not talk about the bank bail out of the 90's.
I assume that since it was done under the radar of most citizens the financial markets seem comfortable just ignoring the fact that the banks have never had to pay for the free ride they have been given over the past couple of decades.
Why can't the US government claw back the taxpayer dollars from the 90's?
'Quelle Surprise' indeed! I still don't know what that means.
Any reports that regional and community bank are having problems does not surprise me. My response is that it's about time we had some recognition of the problem.
To greater or lessor extent, every player in the economy bears responsibility.
What needs to be occuring is the extinguishment of that debt that cannot be serviced.
Ultimately we will find that some 70% of all of the subprime loans will have been liquidated by either repudiation or the substantial modification of the unpaid balance.
Easy credit is rather like a narcotic, euphoric in its initial use and nearly fatal in withdrawal.
Why did the Fed 'stress test' the 19 banks? What was so special about them? They are primary dealer banks and the treasury needs them to facilitate the financing of the Federal Government.
If no one will buy the Treasury Debt, what is the probable outcome? Both the Fed and the Treasury have acted to mitigate such a collapse and the chaos that would ensue.
Now, we as a society have to demand that the Administration and the Congress eschew the theater of stress testing and come to grips with the self evident need to reinstitute some form of Glass-Steagell legislation.
As a part of that reregulation we need to examine the fact that the SEC can only engage in the regulation of that which is a defined tort when in many instances the committed tort is a felony.
In my view, the witting sale of difference contracts that could not be honored is a felony and should be treated as such.
We need to honor the contract of our Constitution and demand of our elected representatives that they do their duty and work to preserve, protect and defend the Constitution.
Recognize that the Federal Reserve System is a government sponsored oligarchy and that in that circumstance there is created a conflict of interest wherein Government incurrs self serving debt used to pander to an ignorant populus.
If there are to be government programs that focus on social welfare, then society must be willing and able to pay for those programs.
If there is to be a sovereign currency, that currency must be capable of statisfying the principal functions of money; medium of exhange, unit of account; and critically, a store of value. This latter function evaporated in 1971.
From the article:
First, it is insane to allow banks that are too big to fail to grow, much less grow massively.
Second, it is particularly insane to allow BB&T to be the acquirer, though anyone relying on the New York Times’ analysis would think the opposite. (So, the subtext is the continuing failure of financial analysis by many prominent financial reporters.)
Thats a lot of insanity. But I'd say the greatest insanity is having the people who don't understand that loans have to be paid back, and that crap shacks in Fresno aren't worth half a million, still working in finance.
From "Anonymous Monetarist"
Many, including the IMF, expect total global credit losses to approach $4,000bn as the economic slowdown means that more traditional forms of lending become toxic. Assuming banks account for three quarters of losses, and they have already torched $915bn, according to Bloomberg, that equates to 14-odd years of revenues (other things, such as capital ratios, being equal).
Thanks "Anonymous Monetarist" – good point. Re-enforces my belief US=Japan
To quote the Fed, "We will pay any price (i.e., taxpayers), fight any foe, bear any burden (well, the taxpayers), to ensure the survival of the US Financial system.
Debt is wealth, borrowing is income.
Yves,
I have heard some criticisms of the stress tests from both sides, but they tend to be very superficial. Can you share your key criticisms?
For the most part, I agree with your comments, though would perhaps not be quite so harsh. From a very high level, the basic assumptions for the stress tests seem reasonable. The assumptions look optimistic when it comes to unemployment. They are beginning to look OK to pessimistic when it comes to home values. Overall, the loan loss projections seem reasonable. It is looking like we might see the base case materialize. Capital markets risks seem like a crap shoot, so it’s tough to make an assessment.
The main problem with the stress tests in my view is that the analysis looks forward two years, apparently making the implicit assumption that future earnings will be sufficient to offset losses once we make it through year-end 2010. The path it seems we are taking – one of “kicking the can down the road” – means that we could be looking at another two years of loan losses in 2011-2012 similar to what we are experiencing now (or perhaps worse in the case of commercial real estate).
Even if the stress tests were perfect, it seems like a somewhat strange exercise, but one that does more good than bad (but maybe not by much).
"If they can keep the shell game going long enough, and they can keep a steep yield curve, the banks will earn their way out"
It is always good to remember that steep yield curve is not coming out of any increased value being added to the economy but is rather capital being siphoned off of more productive sectors of the economy and ordinary individuals. There is an ethical problem with doing this but there is also a practical one: bank losses are (as anonymous monetarist) points out, just too large. They are too insolvent to bail themselves out even at everyone else's expense.