The Stress Tests: Designed to Help Banks Raise Capital 17 comments
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Most critics of the Stress Test have missed the point of the tests and underestimate the Obama Administration’s cleverness in helping banks raise capital. The Stress Tests weren’t about regulatory supervision and certainly weren’t an excuse for the Obama Administration to nationalize the banks. The tests were designed to provide standardized benchmarks, assumptions and projections for private investors to evaluate banks and decide whether or not to participate in recapitalization transactions.
Obama’s ploy to help investors help themselves invest in banks seems to be working. Since the Stress Test results were announced the unthinkable has happened. Two banks, Morgan Stanley (MS) and Wells Fargo (WFC), executed public offerings of stock that went well. And, the bank everyone loves to hate, Bank of America (BAC), was up more than 60% for the week making it possible for them to sell common equity to private shareholders.
For each bank that was “stressed,” investors have been provided a government sanctioned set of financial forecasts to debate, criticize and analyze. Without government prodding and help this information never would have made it into investor hands because of legal risks and securities law restrictions. And, even if the information was provided, banks lacked credibility so that investors wouldn’t have believed the results. The Stress Tests provide a government sanctioned and verified safe harbor for bank managers to give shareholders “what if” scenarios without being ridiculed or sued. Even better, the Stress Test results are quickly turning into the centerpieces of bank equity offerings which are necessary to recapitalize the industry.
A big problem that the Obama Administration had to deal with when they took office was a failure of investor confidence in banks, management teams and financial statements. After having been “WAMU’ed” to the tune of hundreds of billions of dollars, bank investors were understandably reluctant to put new capital to work in the banking system. In January, investors were convinced that buying bank stocks was the investment opportunity of a lifetime; that is the opportunity to lose a lifetime’s worth of savings in the blink of an eye. Back in January any bank executive that stood up and made a prediction that his bank was solvent was publicly ridiculed. If the public could have tarred and feathered bank CEOs, we would have witnessed a bunch of middle aged guys looking like big fat chickens as they ran around in circles squawking about their lousy jobs and low pay.
When it took office, the Obama Administration quickly realized that if they couldn’t figure out a way to get private investors to recapitalize banks the nation faced the real prospect that most of industry would be nationalized. No business can survive the capital drought that the banks were experiencing. Obama’s economic advisors understood that they needed to immediately change the rules of the game. “Self regulation” and non-enforcement had created a mixture of mistrust and failure that had to go.
Bank management teams were rapidly running out of options. In January investors didn’t trust bank managers to tell the truth about easy stuff like the current condition of their institutions or about current period earnings. And, if investors didn’t trust managers to tell the truth about facts that could be quickly verified, they certainly weren’t going to listen to management’s opinions about tough things like future performance of their institutions based upon esoteric and complicated economic and financial assumptions. Managers knew that if they tried to offer multiple sets of projections with sensitivity analysis for different economic assumptions they would have been immediately mocked in the media and sued by shareholders.
I remember when I was a young professional, working first as a lawyer and then later as an investment banker, the equivalent of stress tests were a pretty important issue in bank recapitalizations. I started my career in the 1980s during what seemed to be a decade of one bank and thrift crisis after another. And, most of my clients were trying to recapitalize to cover for mortgage related losses. Investors were always asking me what the regulators were saying about how much capital my clients really needed and how they were calculating the deficiency. My professional responsibilities prevented me from answering the question but I still believe that many deals happened because behind closed doors management told leading institutional investors what the government thought was needed to fix their institution.
The Stress Test results are the Obama Administration’s answer to the disclosure problem that I faced 25 years ago. But now how much capital the government thinks is needed and how the deficiency was calculated is an open topic for discussion. By providing transparency into what the government is thinking Obama is restoring faith in the system. While almost no one agrees with the assumptions used in the Stress Tests (everyone has their own opinion and is convinced that their assumptions are the only correct ones), there is enough information out in public for every investor to rerun the calculations and come to his/her own conclusions.
Even better, Obama has manipulated the media into becoming his unpaid shill to promote the Stress Test results. Using marketing techniques that rival the best propaganda campaign of any government regime (current or past and good or evil), the Obama Administration orchestrated political theatre that transformed a boring and esoteric banking topic into front page news. TV and radio talk show hosts that last month couldn’t balance their checkbooks became overnight bank experts and started debating Stress Tests with the same conviction and knowledge that they regularly debate politics, abortion, torture and sports. A few nights ago I knew that the Obama propaganda engine had really succeeded when an airport limousine driver recognized me as a guy who is on TV a lot and asked me which banks I thought were going to pass and which banks I thought were going to flunk the Stress Tests. But, before I could answer he told me which banks he thought were “keepers” and which stocks he was shorting. By the time I got dropped off at my hotel I not only knew what he thought but also knew which stocks most of his relatives were buying.
Obama has made it safe for investors to buy bank stocks and participate in the recapitalization of the banking industry. Bank executives have a way to explain their business plans and the risks in their institutions without being belittled. And, investment bankers are practically giddy about their new government sanctioned tool to help them sell bank stocks. Of course, the investment bankers are also grateful for the fees that will be generated from raising billions of new equity for the industry.
Pundits that underestimate the Obama Administration do so at their own peril. Unlike TALF which hasn’t worked, execution of the Stress Tests was brilliant, intuitive and creative. But, then again, not everything that the Obama Administration tries is going to work. The Stress Tests are a big win for the new administration and the nation.
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This article has 17 comments:
Agree totally. It was brilliant. Obama's team is a winner. And the thing that scares the critics and the opposition most, is that time will make this very clear. And it means two terms for Obama.
Obama's brilliance is that he believes what he should do is what is right. Not is what it Republican or Democrat sanctioned or policy. Not what is expedient, and not what is acceptable to one religion or another.
Look at the stupidity being spouted by Limbaugh, and Cheney against smart, well motivated people like Powell. It tells you how they think. They are idiologues so wrapped in their idiology they have become idiots with idiotology instead. It is sad to see and it is incredible when you understand America has been lead by these men along with what's his name again? .... oh yea, Bush....
You speak with anger but you say absolutely nothing alatman. Lets have an idea out of you.
For those who complain of crony capitalism, I would stress that if current trends continue, the bank losses will not be born by taxpayers. As the banks raise capital through public offerings, existing shareholders will be diluted and wind up taking the losses.
As banks announced their capital plans, I did not see any that said they expected to dump legacy assets into the PPIP. Another positive effect of the stress test is to verify that the banks involved are strong enough to hold these assets to maturity, if that is the most profitable option.
Those who buy any stock now are about to be burned. The old wall Street shill game is at it again and as usual, CNBC and Cramer lead the masses astray.
UrbanDweller
You know who owns the largest chunk of those banks and will be diluted? public pension funds, individual retirement accounts, widows and orphans type stuff. And you think Obama is doing a great job because he figured out a way for those suckers to pay for all the crimes and misdeeds of billionaire bankers?
I thought that was what REPUBLICANS were supposed to do, not hardcore liberal Obama sycophants.
I wouldn't say that it was a brilliant idea, but I will say that once Obama painted himself in a corner by announcing this prematurely, he managed to work his way out of it.
In February, the hysteria over banks had reached epic proportions. One element was from economists who may be great at macro analysis but don't understand banking.
Then you had the ideologically based interest in a solution that would "punish" the right people and fed on populist sentiments.
Working backwards through the document, it is a scenario where the banks can eat $1 Trillion in losses and still be standing. For those that haven't read the report -- it states that $400 billion has already been booked (through 12/31) and the conclusion was that an adverse scenario would include another $600 billion over the next two years.
There was also an assurance that the institutions wouldn't fail AND that further support would be at the bottom of the capital structure, so that dilution would be more likely then a full wipeout. After the GSE's and AIG, it would be impossible to get a penny of additional private capital into banks without selling that message.
People leap to conspiracies and stupidities about "helping out cronies" or "billionaire bankers", when in fact the truth is more complex, and involves millions of people (including homeowners, small time investors, mortgage lenders, appraisers, Wall Street firms, Republicans, Democrats, cheerleading media).
The fundamental thing you have to do to keep the U.S. from being a banana republic is to restore the credit markets and lending. Those 19 stress tested banks account for about 40-50% of credit in the country.
You can take a "F%*K Wall Street and Cronies" attitude, and the economy will never come out of the hole.
Anyone in Obama's position, Republican or Democrat, and serious about fixing the economy, would begin and end with the financial firms.
When they are functioning, then there are loans for small businesses and consumers. When they are functioning and the credit markets work, even profitable corporations can get the overnight lending they might need or have buyers for their commercial paper.
Further, smart money is actually buying into financials now, as, about one year from now, all their prices will be higher. It's not a matter of kick the can, where Obama is delaying or hiding some future collapse, and trying to sucker in widows and orphans to prop up banks. The ability to raise funds privately is actually the solution to profitability and viability.
"When [financial firms] are functioning, then there are loans for small businesses and consumers."
That's silly. Marshall & Illsey cut its exposure to small business and deadbeat consumers. They have more interesting things to do:
...trust services, brokerage and insurance services, investment management and advisory services, lease financing, wholesale lending, investment services to institutional clients and venture capital, commercial loans and lines of credit, letters of credit, asset-based lending, equipment financing, mezzanine financing, global trade services, treasury management and other financial services to middle market, corporate and public sector clients, secured and unsecured lines of credit, letters of credit, construction loans for commercial and residential development and land acquisition and development loans, separately managed equity and fixed income strategies, managed asset allocation strategies, alternative investments, M&I’s family of mutual funds, manages the financial affairs of ultra high-net-worth individuals and their families, private banking (credit and deposits), investment, estate and tax planning, retirement plan taft-hartley services, not-for-profit services, north star deferred exchange and trust operations outsourcing.
Net revenue for the Investment Bank segment increased to $8.34 billion from $3.01 billion in the previous year, helped by higher investment banking fees and debt underwriting fees as well as an increase in loan syndication fees.
These equity-issuing banks better be able to improve their businesses consistently from here, now that the gov is passing the burden of the bailout onto stockholders, cuz if the bank fundamentals disappoint, WATCH OUT- stocks will plummet once again.
Yes, gov has found a way to buy time, undoubtedly a good thing. We now need real productivity in the economy.
Are consumers also getting more confident? That would boost their spending habits a bit from these levels, but we need more deleveraging, and more jobs, based on business innovations, growth and investment .
Point is- gov is manipulating- what they say is not what is really going on. And the market will not stay fooled or be so willing to play forever.
At higher and higher stock prices, it becomes "where's the beef?"
I read these articles and posts to hear from those who are checking behind the curtain.
And to learn what I might be missing.
Bring on the good news, anyone!
to ramp equities. It has also allowed the ramping
of commodoties and just about doubled the price of oil. Probably
on balance negative for the economy, unless your name was on one
of the checks, in which case what do you care?