Posted on 05/04/2009 7:54:47 PM PDT by sickoflibs
Last week, when the U.S. Treasury unveiled the basics of their lender “stress tests”, the Fed concluded that “most U.S. banking organizations currently have capital levels well in excess of the amounts required to be well capitalized.” Simultaneously, they also claimed that the banks needed more capital. Apparently the Fed has little understanding of irony.
Why would our central bankers conclude that “well capitalized” banks need “more capital?” Quite possibly, they believe, as I do, that the rosy economic assumptions that form the basis of the “stress tests” may be far too optimistic. I believe that neither the Fed nor the Treasury have any will to paint a clear picture of our financial turmoil. But that won't stop them from operating under those assumptions.
A brief examination of the stress test assumptions shows why the Fed should be hedging their bets.
First, the level of stress in the tests was set unrealistically low. Their absolute worst case assumption was for a GDP contraction of only 3.3 percent in 2009. This comes as first quarter 2009 GDP shrank at 6.1 percent. And the economy is still slowing. To post a contraction of just 3.3 percent for the year would likely involve an immediate reversal in the rate of contraction and outright expansion by the fourth quarter.
The stress test also assumes a worst case scenario unemployment rate of 8.9 percent in 2009. This is also wildly optimistic when unemployment is already at 8.7 percent and rising at some 20,000 each day. Worse still, if calculated on a pre-Clinton basis, to include all those unable to find anything but part-time employment, the current unemployment rate is a staggering 19.2 percent, or just 0.8 percent from official depression levels! It appears that the U.S. is fast slipping from recession into depression, rendering the stress tests almost meaningless other than as a public morale boosting exercise.
Second, the conclusion that “most” of the banks are well capitalized, as the Fed claims, also strains the bonds of credibility. The nineteen banks tested have total assets of $11.5 trillion. Technically, sixteen of these banks already are insolvent. If any two fail, they will exhaust the current FDIC bank deposit insurance fund. Only three of the banks, accounting for just 6 percent of the group's assets, could survive even the most liberal worst case scenario assumed by the Treasury. Meanwhile, the five largest and most vulnerable banks, with about $8 trillion in assets, account for some 70 percent of the group's total assets.
Some observers point to the relative security of the smaller regional banks, which did not engage as heavily in leveraged investments. However, the FDIC list of troubled banks has risen in the past three months from 1,568 banks with about $2.3 trillion in assets to 1,816 banks with some $4.4 trillion in assets. The risk has almost doubled, seemingly overnight!
Finally, by suspending the needed discipline of mark-to-market accounting, the profits of many banks have been massaged deceptively upwards. For example, a ‘real’ loss of more than $2 billion at Citibank was ‘fudged’ into a published profit of $1.6 billion.
The observers at the Fed and Treasury, as well as the most sophisticated investors around the world, are neither ignorant nor ill-informed. Despite their stress tests, they must be aware of the possibility of massive bank failures and terrifying aftershocks. This belief may have been a factor in a rumor, circulated after the stress tests were announced, that defensive maneuvers to avoid a run on the dollar, including the elimination of hedged short sales against the dollar, would soon be announced. If such a rule were to be put forward it would rightly be seen as a precursor to internationally coordinated foreign exchange controls, that would abruptly bring an end to the benefits of free trade.
Meanwhile, China has used its huge domestic gold production to double its gold reserves. Such clear concern over the viability of paper currency may encourage other central banks and even corporations to follow suit, making physical gold even harder to obtain. Gold therefore, is likely to experience renewed buying pressure as panic buying overcomes the downward ‘commodity’ selling pressure of depression.
If you realize both parties in Washington think our money is theirs and you trust them to do the wrong thing, this list is for you.
If you think there is a Santa Claus who is going to get elected in Washington and cut a few taxes and spend a few trillion and jump start the economy, and get our lost money back, this list is not for you.
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Makes sense, a very gloomy sense.
One little picky point I can’t get, is how does China having enormous gold mining capacity, and mining this gold, impact the situation. Is it that the more gold there is in the world, the less it will be worth to everybody? How about US gold mines, e.g., in Alaska? How could/will they affect the situation?
Even Liberal Paul Krugman is suspicious of tests(as is post above):
John Hempton has a good question, which other people have asked me: who is leaking about the stress tests?
Traditionally, leaks to the press come from officials trying to curry favor with journalists, who will treat them favorably in the future. (See Woodward, Bob.) But that’s kind of hard to see as a motive in the case of the relevant economic officials here — possible, or maybe it’s people on the political side of the White House, but it doesn’t feel right.
Alternatively, there’s Yves Smith’s version: these are all trial balloons to see how outsiders will react to different stress reports.
But that just adds to the bad feeling about all this. Even Brad DeLong, who has been relatively sympathetic to the administration here, is disturbed by the idea that regulators are negotiating with the banks about the test results. Now it seems as if the report’s contents may also be dictated by what, based on the response to leaks, the informed public is willing to swallow. (”Would you believe it if we say Citi is fine? OK, what if we say they need $5 billion? Not enough? How about 10?”)
I hope I’m not being too cynical here. But it would be nice if the administration would, just once, do something to dispel that cynicism
The writer wants us to buy gold. China has many dollars with little use for them. Gold is the Safe Haven supposedly. So if China buys the gold mines that limits the supply. They should really buy energy, wouldn't you think? like oil wells.
Good thing the FDIC has enough funds to insure less than 1% of demand deposits!
Very interesting. Thanks for posting.
FDIC Chairman Sheila Bair - a power-mongering holdout from Bush administration - is trying to grab as much power (and consequently, money) to FDIC as she can. She was also behind loans “cramdown” and “bad bank” ideas, both of which had been rejected by Bush cabinet and Treasury, and the Fed.
She had more success and influence in Obama administration.
Unless they expect too to be pinched by the globull warming madness, which will depress the price of carbon fossil fuels.
So maybe if she gets the dough FDIC will be able to pay off 1.1% rather than 1% of existing deposits. Whoop de do....
I doubt the FDIC is worried about running out of money. It has friends who can always pick your pocket to get needed funds, or should that fail, just print more money.
Wouldnt you love to run a scam like this one?
Yeah, we’ll all pay a big inflation tax to make everybody whole. I feel SOOOO much better.
***Wouldnt you love to run a scam like this one?***
I don’t think my conscience or my economic/political philosophy would let me. Although you know what they say about power corrupting and absolute power corrupting absolutely...
bump ... I’m expecting reality to come crashing down into the stock market around 5/15
F.D.I.C. Chief Calls for Broader Powers for Agency - NYT, April 28, 2009
Instead of just seizing commercial banks, Ms. Bair said the F.D.I.C. should be able to take over troubled insurers, bank holding companies and other insolvent financial institutions and force stockholders and bondholders to bear the cost. “Viable portions of the company would be put into the good bank, while the ailing portions would remain at the bad bank to be sold or closed over time,” Ms. Bair said at a speech at the Economic Club of New York. ..... The chairwoman of the Federal Deposit Insurance Corporation, Sheila C. Bair, said in a speech on Monday that her agency should have broader powers to take over and close a variety of financial institutions to prevent taxpayers from shouldering the losses on firms deemed too big to fail.
U.S. Lawmakers Consider Bair’s Suggestion to Limits Banks’ Size - BL, April 22, 2009
Bair didn’t offer a proposal, suggest how to limit the size or specify the ideal size, said Representative Edolphus Towns, a New York Democrat. “That was the interest, to make certain that we don’t have this problem again, that these institutions get too big to fail, in the interest of consumers.” Democrats invited Bair to a closed-door Washington meeting for a briefing on the banking industry and discuss a request to expand the FDIC’s borrowing authority from the U.S. Treasury to $100 billion from $30 billion. Bair has said an increase will help instill confidence in depositors that the government stands behind their FDIC-insured accounts after more than two dozen lenders were shut this year, lawmakers said after the meeting. ..... ..... She said in March that regulators need to impose “higher capital requirements” to ensure banks have enough capital to withstand worsening economic scenarios.
Basically, by raising capital requirement she is holding large banks from repaying TARP loans, which most (except horribly mismanaged Citigroup) want to do as soon as possible to stop them being held under Obama's boot. She / FDIC has also seized or threatens to seize several small banks that had / have enough or even more than required amount of capital reserves.
FDIC Bair(s) Teeth - NYP, April 8, 2009
..... The FDIC's panning of the stress tests highlights the growing rift between Bair and Treasury Secretary Tim Geithner over how to fix the ailing financial sector. .....
She is also looking at the Treasury job should Tim Geithner become even more of liability and is forced out, and reputed to be near the top of the replacement candidate list.
We had a test case. Bush gave in on ethanol and oil prices skyrocketed. The only way carbon fossil fuels could be depressed is if something cheaper is found. I go with Jim Rogers, long term prices will be very high. (so far cap and tax is not going anywhere.)
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