Stress Test Results Seem to Be Changing Daily

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Includes: BAC, C, GS, KEY, RF, WFC
by: Deep Value Guy

Different stress test results are being leaked every day. First Citi (NYSE:C) was reported to need capital, then BofA (NYSE:BAC), then Regions (NYSE:RF) and KeyCorp (NYSE:KEY), then Wells (NYSE:WFC), then as many as 14 of the 19 being tested. Now Treasury/Fed seem to have settled on 10 needing capital. But the official announcement is still a day away, so who knows what the results will be? It’s been noted by many commentators that this follows the administration’s pattern: leaks as trial balloons. Can the market handle news that 14 banks need a total of $50 billion? No? Then we’ll say 10 need a total of $30 billion. And if the market isn’t willing to provide that capital, we’ll provide it ourselves by allowing bogus conversions of preferred to common.

[Why aren't banks selling stock right now? Goldman (NYSE:GS) sold $5 billion. Have others done secondary offerings that OA has missed? With bank stocks in the stratosphere relative to two months ago, why aren't they taking the opportunity to raise new common equity the right way?]

The problem with this exercise is it’s very clearly not an honest appraisal of banks’ true health. Nor was it intended to be. Geithner announced the stress tests and allowed folks to believe he might use the results to shut down insolvent banks, but early in the leaking process it was established that all of the banks would pass the “test.” The point was never to resolve the banks, of course, it was to play for time. Q1 earnings were artificially inflated by accounting changes and trading gains. In the meantime, Geithner has been working behind the scenes to rescue banks from their assets (PPIP) while the Fed sped up its printing press to promote a refi boom and hold interest rates artificially low.

Roubini/Richardson note in an op-ed in yesterday’s WSJ that “we can’t stabilize banks forever.”

…the overall message [of the stress test results] is that the sector is in pretty good shape.

This would be good news if it were credible. But the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak — $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. With the U.S. banks and broker-dealers accounting for more than half these losses there is a huge disconnect between these estimated losses and the regulators’ conclusions.

Unfortunately, R/R go off track advocating the PPIP. They say it will promote price discovery, which just isn’t true. The price discovered by PPIP auctions for toxic assets is likely to be over-inflated by too-cheap, too-plentiful leverage being offered by FDIC. If non-recourse leverage is needed to jack up returns such that toxic assets can be sold, that means they are still fundamentally overvalued.

R/R’s larger point is a good one, though: the bank crisis can’t be resolved until creditors are forced to eat losses as failed banks are put into government-sponsored receivership.