The US Government has released more details of how it would conduct ‘stress tests’ and how it would give the banks six months to raise private capital and if they fail, the US government would provide capital and that too only preferred capital and not equity capital. Such capital would convert in seven years into common equity, if the banks want it.
The ‘stress tests’ would assess whether banks have enough capital and also the composition and quality of their capital. There is no explicit reference to ‘asset values’. It is fascinating. It shows a mental reluctance to come to grips with the real issue – the presence of assets in the books (there may be still some outside, who knows?) that have no value or little value.
Secondly, these ‘stress tests’ will be conducted by banks themselves. Why? Why cannot they be done by independently appointed experts and why cannot these be published?
I am afraid that as Paul Krugman wrote in his blog on 24.2.2009, these plans are about re-arranging deck chairs and hoping for the best.
In this one, he links to the criteria for stress tests that the FDIC has set out (there is a link to PDF file from FDIC). He examines the ‘stress scenarios’. They are not ‘stressful’ at all. So, they are meant to make the banks survive the stress tests? For me, it is somewhat unbelievable that they are refusing to face up to reality
See this one on ‘All the President’s zombies’:
The last sentence is exactly in line with the medical analogy I had used in my email yesterday:
“At most we’ll get a slow intravenous drip that’s enough to keep the banks shambling along.”
Of course, this quote is not from Dr. Paul Krugman.
If some one asks me whether there is value in the American banks or the European ones, my answer is: “why bother finding out?”.
U.S. Sets a Six-Month Deadline for New Bank Capital (Update5)
2009-02-25 23:16:31.404 GMT
(Adds context on conduct of tests in fifth paragraph.)
By Rebecca Christie and Robert Schmidt
Feb. 25 (Bloomberg) — The government set a six-month deadline for the biggest 19 U.S. banks to raise any new capital deemed necessary after a mandatory review of their balance sheets.
The regulators will oversee the so-called stress tests by the end of April, which will identify how much extra cushion each bank will need, the Treasury said today in Washington. Lenders will have six months to raise private capital or accept government funds and the conditions that come with it.
“While the vast majority of U.S. banking organizations have capital in excess of the amounts required to be considered well capitalized, the uncertain economic environment has eroded confidence in the amount and quality of capital held by some,”
the Treasury said, announcing guidelines for new bank reviews.
Any new government money will come in the form of convertible preferred securities, which would acquire voting rights if converted into common stock. U.S. officials, speaking to reporters after the announcement, said there would be no limit on how much money the program could provide banks, raising questions about whether the Obama administration will need to ask Congress for more bailout funds.
Conduct of Tests
The banks themselves will analyze system-wide losses under two economic scenarios, along with forecasts for internal resources to absorb the losses. Supervisors will discuss the results with the companies and determine whether an additional capital buffer is needed, according to the Treasury.
Federal Reserve Chairman Ben S. Bernanke said today that not all of the 19 banks will likely need new injections of government funds.
The Treasury has used about half the $700 billion allocated by Congress for the banking rescue, and most of that was spent under former President George W. Bush.
Banks receiving the new money would be pressed to show how they will lend more, officials said.
In their assessments, regulators will incorporate off- balance-sheet commitments, earnings projections, risks of the banks’ business activities and the composition and quality of their capital, the Treasury said.
“We wanted to bring a more consistent, more conservative, more forward-looking approach so that we help this cloud of uncertainty that’s hanging over our financial system that’s getting in the way of credit flowing again,” Treasury Secretary Timothy Geithner said in an interview today with public television’s “The News Hour With Jim Lehrer.”
Geithner also said nationalization is “the wrong strategy for the country and I don’t think it’s the necessary strategy.”
Losses will be projected under two sets of projections.
Under the “baseline,” the U.S. economy will shrink 2 percent this year and expand 2.1 percent in 2010. The “alternative more adverse” set of projections has gross domestic product dropping by 3.3 percent this year, with a 0.5 percent expansion in 2010.
Any capital investments made by the Treasury will be placed in a separate trust to manage the government’s investments in financial companies.
If it acquires voting rights, the Treasury said it would release guidelines on how it will handle the situation before completing any transactions. The shares would convert either at a bank’s request or at the end of a seven-year period.
“U.S. government ownership is not an objective” of the program, the Treasury said. In cases of significant federal investment, “our goal will be to keep the period of government ownership as temporary as possible.”
While the biggest 19 banks will be required to undergo the stress tests and get more capital, smaller banks can also apply to participate in the Treasury initiative, known as the Capital Assistance Program.
Bernanke said today that while the U.S. government may take “substantial” stakes in Citigroup Inc. and other banks, it doesn’t plan a full-scale nationalization that wipes out stockholders.
Nationalization is when the government “seizes” a company, “zeroes out the shareholders and begins to manage and run the bank, and we don’t plan anything like that,” Bernanke told lawmakers in Washington.
Today’s statement didn’t specify any potential limit on the amount of money involved. President Barack Obama late yesterday signaled that the administration will seek more money from Congress for the effort to break the back of the credit crisis.