Stress Test Zombies: Not Too Big To Fail? Tough Tootsies Little Banks!
March 13, 2009
Stress Test Zombies: Not Too Big Too Fail? Tough Tootsies Little Banks!
There are certain professions in which the collective genius of the American people dominates the field: semiconductor design, fast food product differentiation, fire-control systems for air-to-air combat, and con artistry. That these are not, at the moment, sufficient to earn a current account surplus, is a problem being worked on, not least by the service exporters in the latter occupation.
Last week, we learned from Fed Chairman Ben Bernanke and
Treasury Secretary Tim Geithner that Washington lacks the guts to fix the
problems eating away at the US financial system, at least so far. So large
are the derivative-fueled losses and so majestic the collective incompetence of
the Congress, regulators and the Sell Side dealers on Wall Street in enabling
these losses, that the judgment of the single party state
called Washington is to simply hide the problem under an ever-widening
Notice that there are no foreign-owned banks as part of the stress test group. Note too that there are several banks on the list that are rated "F" by the IRA Bank Monitor as of year-end 2008. These negative ratings are driven both by negative ROEs as well as above-average realized credit losses.
We see two issues facing Bernanke, Geithner and the Obama Administration when it comes to the cowardly "feed the zombies" approach articulated last week. First, it is not sustainable financially and must eventually be changed because of funding constraints. And two, the policy of subsidizing the bond holders of the largest banks is unworkable politically and must eventually also be changed to conform with domestic political reality. That's right, at some point the Obama Administration may need to choose between our foreign creditors and American voters.
The Bernanke/Geithner approach to not dealing with the financial crisis amounts to a hideous public subsidy of the global transactional class, a transfer of wealth from American taxpayers to the institutional investors who hold the bonds and derivative obligations tied to the zombie banks, AIG and the GSEs. All of these companies will require continuing cash subsidies if they are not resolved in bankruptcy.
Remember that the maximum probably loss ("MPL") shown in The IRA Bank Monitor for the top US banks with assets above $10 billion, also known as Economic Capital, is a cash number representing the amount of incremental capital the banks may require to absorb the losses from a 3-4 standard deviation economic slump, such as the one we have today. If you include the subsidy required for the GSEs and AIG, the US Treasury could face a collective funding requirement of $4 trillion through the cycle. Do Ben Bernanke and Tim Geithner really believe that they can sell such a program to the Congress? To put it in perspective, the $250 billion in the Obama Budget for additional TARP funds will not quite cover Citigroup (NYSE:C).
Bottom line: The policy decision articulated this week by Bernanke and Geithner represents the largest transfer of wealth in American history, yet no legislation and been passed and no meaningful debate has occurred. The biggest danger facing the markets is that Ben and Tim still do not seem to have a clue what to do about the big banks -- other than to write more checks against the public trust. The conflict over this decision to pass the cost to the taxpayer, between the Fed, Treasury and the Congress, on the one hand, and the Wall Street dealer banks is staggering, yet nothing is said in the Big Media.
The Fed and Treasury claim that situations like C and AIG
cannot be addressed idiosyncratically, to paraphrase our friend David Kotok, but
the reality is more complex. Fact is, the Sell Side dealers have leveraged the
real economy via OTC derivatives to such a degree that bailing out toxic waste
sites like AIG, several large Euroland banks and the world of structured finance
could cost trillions of dollars. That is the true cost of the
crisis. The only issue is whether we recognize it directly, via a public
resolution, or hide the costs via public subsidies and future
Mark to Market Accounting
To answer your many questions about our view on mark-to-market accounting, the damage - or adjustment - is done. We opposed the way the return to FVA was handled because it was too much driven by accounting and not enough other issues around business reporting. We need to be cognizant of not just accounting goals and rules, but also business reporting, investor relations, legal and business issues in order to assess this question.
We like the idea of more disclosure. We just think that swings in short-term prices observed by M2M need be confirmed by time, then you begin to convince us that the observed average price over a period of time equals value and should affect assets or income.
We submitted individual comments on same to The Financial Crisis Advisory Group (FCAG) of the IASB and FASB. Members of the financial community who care about M2M should attend the open meetings hosted by FASB and submit comments to the FCAG as well.
When we stated on Bloomberg TV a while back that M2M was an attempt by the accounting industry to deal with the growing opacity and deliberate inefficiency of the OTC world, our friend David Reilly ran downstairs and declared our conversion to the forces of good "on the road to Jerusalem." Fair enough. Our recommendation is that we continue to report M2M price swings, but be more reasonable when it comes to writing down performing assets vs. income and charging-off credit exposures that are paying as contracted. The inclusion of something that resembles an impairment test may be part of the eventual solution.Questions? Comments? email@example.com
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