Seeking Alpha
Profile| Send Message|
( followers)  

There are two things you should be paying very close attention to:

1.The stress test results

2.The way the government allows banks to pay back TARP funds.

It’s important to watch these two stories right now because (to simplify things) our entire banking system literally hangs on them. Let me explain.

Story #1 – The Stress Test Results

I have written on point number one in the past and many of you may have read my words. From what I wrote previously:

The Federal government is going to release some of the results of the now infamous "Stress Test" which was run on our nation’s banks. I don't expect the results that come out of any statement from them to be useful, but at least we won't have to hear about the test itself anymore. When you do hear the results please consider the "stress" levels that were used in the "scenarios" tested. Why? Well because the worst case scenario used an unemployment rate of slightly higher than 10% and anticipated the crisis ending by late 2009, they also assumed housing prices would fall 22% or less by the end of the year. How on earth is this a representation of the worst case scenario? Most of these assumptions are already true for crying out loud! If anything, I'd say this is a best case scenario because it assumes we are at the bottom already.”

Consider the following:

To the stress test assumptions on unemployment: Already U-6 unemployment (real unemployment) is at 15.6% and "government" unemployment; U-3 is at 9.8%. Based on that assuming a 10% unemployment rate in the worst case scenario seems almost absurd.

To the stress test assumptions on housing: According to the Wall Street Journal today Housing Price Drops Are Leaving More Underwater. If more are going under water each day and we’ve already had a decrease in home prices of 22% where does that leave this assumption?

Lastly, although not specifically addressed above, please consider that roughly 80% of the states in the US are also insolvent. (On that point check out this interactive map at CNN, it’s pretty interesting.) If the states don’t have any money it’s fairly easy to assume that state employees will start getting laid off. This issue is particularly important when you consider that our State and Federal governments are one of the only places where jobs have been recently “added”. To that point it is worth pondering the fact that the government can only generate revenue through taxes and need tax money to pay for things; things such as employees. Considering the private sector has shed jobs for the past 15 months and has little possibility of showing a net add to employment anytime soon. I’d say our banks have even more problems ahead as government tax revenues dwindle.

In conclusion the only way the stress test assumptions hold any weight is if the government is correctly calling this (as in right now) the economic bottom. If it is not the bottom the stress test is utterly useless because it has not considered things getting any worse than they are today. However, what they have done (inadvertently) is finally shown us how weak our banks actually are as of the date the tests were run. Now onward to Story #2.

Story #2 – How Banks Are Allowed To Pay Back TARP Funds

Today the story broke that the government is working (potentially illegally) to stop some banks from repaying TARP (bailout) funds. Specifically, according to the Wall Street Journal:

“Banks that want to return Troubled Asset Relief Program funds will have to demonstrate their ability to wean themselves off another major federal program, according to senior government officials, making it less attractive for some banks to return the money.

The other program, a guarantee of debt issuance offered by the Federal Deposit Insurance Corp., allows firms to borrow money relatively inexpensively. Banks have $332.5 billion of debt outstanding under this program, which began last fall.”

Why would they do that?

From story #1 above we know that it’s likely the worst case scenario used in the stress test is not very realistic or helpful. To that point, as of today, we already know that Bank of America needs another $34 Billion to stay afloat and that Citigroup will need at least $10 Billion. Based on the government sponsored figures above, we can officially conclude what we’ve all already known; both Citi (NYSE:C) and BoA (NYSE:BAC) remain insolvent. Now review the following also from the story above:

“The requirement would likely cut right down the dividing line on Wall Street. JP Morgan Chase and Goldman Sachs have already issued debt not backed by the FDIC. Citigroup and Bank of America have not; both are expected to have trouble doing so.”

The reason the government may want to do this is to try and stop a run on Citibank and Bank of America. If the government were to allow (for example) JPMorgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS) to pay back bailout funds, there is a risk depositors would finally leave both Citibank and Bank of America for each of the respective banks. Repayment would draw a clear line between banks with regard to their overall solvency, as some of the nation’s biggest banks would no longer be under the bailout umbrella. The government will go to great lengths to ensure this does not happen.

If repayment was made, how could Citibank and Bank of America compete? How could they stay relevant? What value would be left within them if all of their deposits went to competitors? How could our government justify the trillions of dollars we spent on trying to keep them afloat while private companies thrived? These questions and countless more like them ensure that the government will do everything in its power to keep our banks on a level playing field. Whether they do it legally or illegally is another story, but it certainly doesn’t look like the bottom from here.

So what can you do about it? You can’t specifically do anything relative to the banking issues above, however there is hope. You can make sure you shy away from dealing with or investing in a bank which “fails” the stress test. In addition, if you know the banking system is unsound it may be time to diversify away from your US Dollar holdings and move towards either Yen or Gold. Whatever you do, pay attention to these two issues because the way they pan out may ultimately be the final chapter in the bailout story.

Source: Stressed Out Financials