WTF? Pre-Determined Stress Tests?
Posted: February 22, 2009 Filed under: Global Financial Crisis, No Obama, president teleprompter jesus, Team Obama, U.S. Economy, Uncategorized | Tags: Bank Stress Tests, Obama Bailout, Predeterimined Stress Tests 2 CommentsI finally have a bit of time to catch up on reading. I’m hosting 10 of my youngest daughter’s college friends for Mardi Gras in a very small house and it’s as wild as it sounds. I read this on Naked Capitalism and just didn’t even know what to say. So I’m going to throw it to you. Now mind you, this is an economics site and not a political one.
We have been skeptical that the pending Treasury stress tests on banks, designed to ascertain their state of health, were inadequately staffed and therefore could not do the job properly. Our big concerns were that they had too few bodies to e test financial data versus underlying documentation adequately (usually done on a sampling basis) and they lacked the expertise (and perhaps the mandate) to vet risk models (which we all know have performed impeccably over the last two years.
Is it a test if the results are pre-determined? Apparently Team Obama thinks so.
I’ve been wondering what exactly this stress test was going to be myself and how they were going to pull it off. I’ve worked in commercial banks, savings and loans, and at the Fed as well as the educational background and I’ve been scratching my head since it was first announced. No wonder the Obama administration is sounding so firm on the no nationalization issue. They’ve planned what they’re going to get ahead of time.
This report and picture from CNBC.
Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.”
Yes, read it again. The process is to show us that the banks are okay. No wonder there’s no discussion of the Swedish or German approach to Banking crises. We’re going to be ‘shown’ everything is okay even under the ‘worse’ outcomes. Details on the worst scenarios are supposed to be out on Wednesday, but really, we’ve heard this before. Remember I mentioned in my last thread that much of the definitions had to do with what type of stock (common, preferred, some hybrid) winds up flowing from the Treasury to the target banks? Here’s another on the money paraphrase from the CNBC story.
The key misunderstanding in markets, officials believe, is how the public-private partnership will work and the way that new government capital, in the form of mandatory convertible preferred shares will become common equity.
One official said the public-private partnership will be voluntary so there will not be no mandate that banks offload assets at a loss. The official added that additional government capital will go into the banks as mandatory convertible preferred. Those shares remain preferred until realized losses and capital needs trigger conversion to common. As a result, the official said, the government may end up with a large stake in a given bank over a period of time, but it wont’ happen overnight.
May I suggest some new Savings Vehicles for the Obama Years?
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If the government doesn’t follow the German model and continues to buy preferred stock, is there a tipping point where they’ll buy so much preferred stock, that they’ll essentially own all their assets anyway? From what I understand, the governemtn won’t “own” a bank until it purchases a majority of common stock.
Preferred stock is a little different from common in that it doesn’t defer residual asset ownership the way common stock does. Common stock holders are considered ‘the owners’ of a publicly held institution. So yes, the government doesn’t ‘own’ the bank until it exercises the convertible warrants on the preferred stock and switches it to common stock. If it exercised this option for citi bank it would be the majority owner right now. As long as it’s in some kind of hybrid preferred, the bank is technically not nationalized or owned by the government.