What If the Stress Test is Just the Opening Act

Today, the government will begin discussing the results of its stress tests with heads of the nation's 19 larger banks in meetings in Washington and will release the methodology of the tests to the public. Then, of course, we'll all sit around twiddling our thumbs until May 4th, wondering what comes next.

The number circulating today is $1 trillion -- that's new capital needed -- which is an estimate produced by brokerage firm Keefe, Bruyette and Woods, based on its own stress tests. The number has the advantage of being large and round and largely without competing figures, and so it has made its way into every newspaper preview of the day's meetings. I have no reason to think that it's not in the right ballpark. Certainly, estimates of losses from a range of sources indicate that hundreds of billions of dollars will be necessary.

What's clear is that the test results will be unable to avoid playing favorites. Recommendations will not be one-size-fits-all, but will be tailored based on the quality of a bank's assets, its likely earning power, and its exposure to other, potentially weak, institutions. This creates an obvious problem; the banks in the best condition will need to raise the least capital and will have the easiest time doing it. There's a distressing corollary; those in the worst condition will be required to raise the most capital. They'll have an awful time of it. Private investors will be uninterested, because the possibility of a good return will be slim, and because government could come careening in at any moment, messing up whatever calculation convinced an investor that Citigroup (C) was a promising bet.

Which will leave the government there to fill the hole. But how? If we imagine, not unreasonably, that there will be a need for a few hundred billion between Citigroup and Bank of America (BAC), then we find ourselves facing some tricky questions. Where, for instance, does the money come from? How does the government get it to the banks without accidentally winding up with very large ownership stakes? What is the game plan?

And to me, that last is where all the suspense surrounding the stress test lies. The actual results are the opening act. The main event is what the government rolls out as its solution. I have this uncomfortable feeling that if the stress tests reveal anything like the true picture at a Citigroup and the policy response is a combination of an increase in equity stake, fingers crossed for private recapitalization, and the promise of PPIP, markets may be very upset indeed.

Comments

[Ishortyou:]

ha ha those politicians fell victim of their own tricks...stress test? yah..trying to look good to cash on popular votes for the next coming elections? think again...., now they are with the dilemma of the stress test, if some banks fail to pass, that will triggered a run on the bank not only in them but in almost other banks that even passed, and that will kill them even when they are already in good position to withstand the current situation (Wachovia sounds familiar?), panic starts even with bad results for some and not all and then the politicians will try to blame someone for their own stupid political tricks...man damn politicians this system sucks really. The media frenzy trying to improve their ratings will start talking about it non stop and the public will panic. They just should have leave thing the way they are period...

Apr 24 11:58 AM

[schlumpf:]

be sure the test send the markets higher ( better than expected like everything). After nearly 2 month " better than expected" and goverment support I cant suggest the markets are going down.

Apr 24 12:05 PM

[Repsonsible...:]

For me its SIMPLE ,, GOLDMAN got $180 BILLION Tax Dollars through the back door of the AIG Bailout . To Pay Off GOLDMAN at 100% on their BAD CDS s
NOBODY ELSE GOT Paid on them most lost 99% . GoldMan OWES the US Goverment $180 Billion , Maybe with the NEW TARP FRAUD Investagations it will finally be made Public and GOLDMAN will have to PAY Back that $180 BILLION !

Apr 24 12:33 PM

[sr9web:]

It's outrageous that we bailed out Goldma fat-cats via AIG backdoor. GS is agressively black-box trading the market in big numbers every day. Why should we the taxpayers make it any easier for those rich slobs to fleece us in the market?


On Apr 24 12:33 PM Repsonsible Citizen wrote:

> For me its SIMPLE ,, GOLDMAN got $180 BILLION Tax Dollars through
> the back door of the AIG Bailout . To Pay Off GOLDMAN at 100% on
> their BAD CDS s
> NOBODY ELSE GOT Paid on them most lost 99% . GoldMan OWES the US
> Goverment $180 Billion , Maybe with the NEW TARP FRAUD Investagations
> it will finally be made Public and GOLDMAN will have to PAY Back
> that $180 BILLION !

Apr 24 08:15 PM

[fireball:]

i am wondering if this will all be a way to get control of the small community banks which have behaved in a responsible businesslike way.
if the federalis are to have a fascist banking system under obamamama they can't have any small pockets of free enterprise out there competing.
equal poverty for all wheher you have been industrious and responsible or lazy and worthless.

Apr 25 09:32 AM

[henarl:]

Posters are wondering how Goldman was and is able to come out of this economic disaster (which they were a big part of creating) so much better than any other company. The answer is simple: Decisions of the Fed and Treasury are being made by Goldman insiders and their friends. Actually, in financial matters Goldman IS the government. Hopefully Andrew Cuomo will continue with his investigation and not be disuaded by the awesome power of the federal govt.

Apr 25 11:15 AM

[henarl:]

No bank will "fail" the stress test. It's just a govt. public relations scam to pacify an upset population and forestall any bank runs.

Apr 25 11:20 AM

[Old Trader:]

I agree its a public relations effort, but given the ever growing awareness of what TPTB are attempting, I'm increasingly questioning at how effective it'll be at doing either.

Even if no results are publicly disseminated, and there're no credible "leaks" (which might be a big "if"), the actions of any of the 19 banks involved in the test, in terms of efforts to raise additonal capital, will make it plain to all and sundry whether they "passed" or "failed".


On Apr 25 11:20 AM henarl wrote:

> No bank will "fail" the stress test. It's just a govt. public relations
> scam to pacify an upset population and forestall any bank runs.

Apr 25 07:53 PM

[Econ 101:]

Is this why Spiltzer was trapped and disposed of as Governor of NY? Were the big boys getting rid of someone they thought would stand up for the little guy?? Did they think they had Cuomo in their pocket and he would roll over for them??

Goldman is a terrorist organization, second only in thuggery to the congress. While you are indicting Paulson, Bernanke and Geitner please include Barney Frank, Charlie Rangle and Nancy Pelosi!

Apr 26 12:38 AM