Is the government stress test on the nation's largest banks a sham?

Are there any ulterior motives behind the Government so called “Stress Test” on 19 of the Nation’s Largest Banks? By Ofuoma Odje

On April 4th 2009, Treasury Secretary Tim Geithner testified before a congressional oversight committee headed by Elizabeth Warren and stated that "the vast majority" of banks could be considered well-capitalized.

If this is the case, why is the Government still talking about the stress test and the possible ramifications for the banks?
Why is there so much back and forth between the Banks and the Treasury over the stress test? And why are the results still being delayed?

The true motives behind this stress test are still unclear at this time, but certain conclusions can be drawn based on the chatter from the Treasury and other Government officials.
From an objective point of view, the stress test looks like a directed effort at State control of the banks deemed to need more capital by the Treasury.
In other words it appears the so called “Stress Test” is a backdoor to nationalization of the nation’s largest banks, to more TARP money from congress, and Government direction of the banking industry.
This means that key functions like control over executive compensation and ousting of CEOs that were formerly reserved for shareholders could now become exclusively reserved for the government.
Treasury Secretary Gaithner made it clear that none of the 19 banks will be allowed fail.

This surely reveals that if necessary, he intends to go back to congress for more TARP money in order to re-capitalize banks deemed as weak per his “Stress Test”.

If this is the case, the stress test is a political exercise that could expose nearly a Trillion Dollars hole in bad assets amongst these 19 banks.
Government remedies for under-capitalized banks
The Government has said that Banks needing more capital will be given 6 months to raise such capital privately, after which they must accept government funding.
The government is currently considering 2 options to address the under-capitalized banks.


Since the TARP funds are running low, the first and most likely action will be to follow the Citigroup model, where the government converts the Banks preferred shares it acquired via TARP funds into common equity.

But what good does this conversion really do? Let’s look at this scenario and its ramifications.

Currently, the Banks have to pay interest to the Treasury on the preferred shares it exchanged for TARP loans. While the government receives interest on those preferred shares, the shares themselves do not bestow any voting rights on the government.
If those preferred shares were converted into common equity, the banks would not have to pay anymore interest on the TARP funds. But there’s a catch.

By converting the preferred shares into common equity the Government does 2 things it clearly has said it does not intend to do. First, it takes a larger or the largest stake in the Banks which is tantamount to semi-nationalization at best along with voting rights to match. For example, if we look at the planned Citibank conversion we would see that the Government stake is increased to 36% making it the largest shareholder with matching voting rights.
Secondly, it dilutes the value of common equity and wipes out shareholders. The worst part of this exercise is that it doesn’t make significant improvements to the banks health. Shareholders are simply wiped out in favor of the Government without actually adding one cent of new money to banks.

Seeing the potential ineffectiveness or damage that can be caused by this conversion of preferred shares into common equity, the next option available to the Treasury will be to approach congress for more TARP money.
If indeed the Treasury follows this cause of action, then it could be well said that the stress test was nothing but a Trojan horse intended to approach congress for more TARP, which of course means more Government Direction of the economy, more Government control of Executive compensation and how Banks are run in the U.S.
The overheads of Government involvement
The TARP however, comes with its own problem. Neil Barofsky, the Special Inspector General overseeing TARP, has warned that the TARP program is 'inherently vulnerable to fraud, waste and abuse.' This risk he says grows as the plan becomes larger and more complex. Already federal investigators have opened about 20 criminal probes into possible securities fraud, tax violations, insider trading and other crimes.

In spite of these criminal underpinnings that could come with the TARP program, it is increasingly becoming clear that this is the path that Gaithner and the Treasury Department are likely to embark on.
So are we just adding to the numerous examples of government failure to provide effective and efficient services to the public?
We already see a slew of these Government wasteful spending and failures all around us.
Government has failed with Medicare and Medicaid to provide decent and efficient healthcare to the uninsured and even to war veterans who have put their lives at risk for the Country. Government has failed to provide high quality education to the public to enable America compete on a global scale and has even failed to provide a fair Justice system at the state and federal levels to protect its citizens.

These are just a few examples of why Government intervention in Private Enterprise could only mean bad news.

Knowing this, what then makes the Government the best choice to run the nation’s Banking Industry in the light of the financial collapse?
Any Bank that needs money to pay its bills simply put should not be a Bank. Something has to fail in order for Capitalism to succeed.

The Stress Test appears to be a mistake by an over-panicked Treasury Dept. who got themselves into a box when they announced that they were going to perform a stress test without thinking about what would come next after the results were announced.
We’ve seen this in the delays and steps taken by the Treasury in connection to releasing the results of the stress tests. First they released the parameters behind the tests, and then released the results to the banks only, and then they moved the public release date from May 4th to May 7th.
They even claimed that prior to the release of the results to the public, they would correct any faults raised by the Banks about the way the tests were conducted. In this case, how then will the stress test offer any transparency?
It is clear that all banks in the U.S. are insured. Why then do we need to know which ones are more equal than the others?
These stress test results could only be harmful to the banks and investors.

It is very hard to say that this is not going to lead to the nationalization of the U.S. banking industry.
If the government is going to have major stakes in banks, control bank lending policy and control employee pay and bonuses there is no question that the banks will be nationalized, at least for as long as they keep government money.
The government however continues to deny this by saying banks should remain private, and that it has no intention to nationalize them. Based on its actions however, an interpretation to what the government is actually saying could be that it desires to keep control over the banks, but does not want to be held accountable.
With government intention to nationalize healthcare, adding the banking sector results in government control of more than 20% of the economy. This does not look like free enterprise and capitalism; instead, it has the flavors of socialism.
Do the banks have alternatives?
The first question that comes to mind when opposing government involvement is that: - can the banks grow their way out of this crisis on their own?
There are other alternatives to the direct government intervention through TARP and Nationalization.
The first alternative will be to relax Mark-to-Market rules. Mark-to-market rules force banks to readjust the value of the assets they hold to reflect current market prices. For assets like mortgage-backed securities the market prices have declined well below the prices at which the banks would agree to sell them. Assets that have not defaulted however continue to generate income and that income makes them worth more to the banks than buyers on the market would be willing to pay.
Nevertheless, under the current Mark-to-Market rules it doesn’t matter that the assets generate income and have not defaulted. Their values must be adjusted to account for what the rules describe as a “hypothetical transaction at the measurement date.”

Mark-to-Market rules are harmful to banks in two ways. Firstly, the banks are forced to take losses on paper as though they were actual financial losses based on fire-sale valuations of securities that they may not intend to sell. Secondly and perhaps the most damaging is that mark-to-market rules are used in assessing banks’ capital requirements. This means that banks deemed by regulators to be undercapitalized are forced to sell forced to sell assets at diminished mark-to-market prices in order to raise enough capital to keep the regulators satisfied.
These forced sales cause banks to lock in losses and drives down prices of similar assets, thus creating a vicious cycle of wealth destruction.
Under pressure from lawmakers, The Financial Accounting Standards Board (FASB) recently relaxed mark-to-market rules.
The changes apply to the second quarter that began in April 2009. The changes will allow banks to value assets at what they would go for in an "orderly" sale, as opposed to a forced or distressed sale. This change however is not enough to help banks earn their way out.
So long as banks are still forced to take losses on performing assets, they face tough choices like accepting TARP money and government control or lose customers and shrink their asset base. We’ve already seen some banks like Citibank and American Express offering customers cash incentive in exchange for either reducing their credit limits or closing their accounts as they move to get rid of customers, reduce their asset base and avoid more TARP money.
Another alternative is for the Treasury to change the Bank Capital rules, particularly on its focus on Tier 1 Capital and Tangible Common Equity requirements. In other words the government could change the parameters of the so called “stress test”. If this were done then the stress test results would not be as harmful to the banks, because it will not force them to require new capital.
Conclusion
The banking system has taken a hard hit. Banks are earning money on some of their products, but capital is being eaten away by the declining value of toxic assets governed by Mark-to-Market rules. The situation can be likened to fighting a cancer. This unfortunate situation is not helped by mark-to-market rules and government capital requirements for the banks.
The current low rates on borrowing can potentially help the banks grow their way out of this crisis if the FASB would do more about mark-to-market rules and if the government would change their capital rules for the banks.
If they did this, the banks will get help to quickly De-TARP and the injection of further taxpayer money in pursuit of a solution to a regulatory problem could be avoided.
The current government actions have done more to politicize a regulatory process more than anything else. This is underscored by the stress test which has been a show trial and political exercise.

The motivation behind the stress test remains a mystery, but it does appear that the Treasury and the Whitehouse intend to pursue the reinstitution of credit by staying on the banks long enough to change the way credit is issued.
Until the government gets out of the way, investing in banking stocks will be purely speculative. Purely speculative like investing in biotech companies who have drugs in clinical trials with the hope that the clinical trials will be successful. Perhaps the wise advice right now is not to invest in banks until the government gets out of the way.
Banks should be regulated by the Office of the Comptroller of the Currency, the FDIC and the Federal Reserve; not by the Treasury and the Whitehouse.

Ofuoma Odje

One tip to keeping runners winning

Training for a 3k, 5k or longer run?

When preparing for a long distance race, we often put all our focus on training hard and improving our lap times, leg strength, endurance and general fitness.

While this is a disciplined thing to do it can hurt rather than help our chances of maximum performance on the day of the race.

In order to avoid that pitfall, here's a helpful tip.

Avoid all serious training in the final few days of the big race.

British researchers discovered that doing serious training 48 hours before the big race reduced by 7 percent the total distance covered by runners.

According to Samuele Marcora, Ph,D., the research showed that the excercises caused a high level of muscle damage which affected the runner's brain and caused him to exert more effort, even when he felt no sore in his muscles

Ofuoma Odje