Stressed Out!

Federal Reserve Chairman Ben Bernanke told Congress on February 24^th that the feds won’t “nationalize” banks, that the worst they will do is take large minority interests in the common (voting) stock. The Fed is talking to Citigroup right now, presumably to increase its stake in this financial behemoth from 8% to 30-40%. How is this not de facto nationalization? Why are playing a game? Meanwhile, house sales continue to fall, job loss is escalating and there is no meaningful credit in the market right now. Lending between banks is virtually non-existent, and I’ve even heard stories of banks refusing to accept “normally same as cash” letters of credit from other banks! American Express is telling some of their customers that they will pay them $300 to give up their cards, and it looks like a tightening of consumer credit in general is right around the corner.

While the President and Congress cry for a loosening of the credit markets, the government bank examiners are telling banks that their balance sheets are questionable and that if they lend, the new criteria make qualifying for a loan nearly impossible. Who’s going to lend against depreciating assets, questionable payables (people and companies that might not be able to pay) and threatened pay-cuts and job losses? If you had money, would you lend it out? And if so, at what interest rate? Precisely the issue.

We all know about the “stress test” that the Federal bank examiners are applying right now to the 20 largest American financial institutions. The goal is to determine which banks can survive, how solid they are and how to deploy the next round of federal bailout money. But financial folks love to play games, and since they don’t want the stock market to write off their shares as valueless or vastly less valuable (which further impairs their ability to meet the “stress test” parameters), they need to try and convince the market that “everything is alright.” But it isn’t; banks have played fast and loose with accounting definitions and valuations for too long, and this game-playing is exactly what got us into this horrific meltdown in the first place.

The issue facing the examiners is what standards should apply to determine bank “health.” The factors which have been included in valuations in the past have included the market capitalization (the value of the company as a whole as perceived by the stock market) of the company as one of the key “tier one” factors that determine how safe and solid a bank is. Added into this “tier one” pile of values are things like preferred stock and a few other “hybrid” financial instruments that combine debt and equity. There is a “tier two category” (stuff like revalued property reserves – that’s makes me feel good… not – yet undisclosed reserves, etc.), but it would get way too complicated to delve into that mash. But how are our lovely banks doing?

In an interview on CBS’ Early Show on February 24^th, FDIC head, Sheila Blair stated: “All these large banks exceed regulatory standards for being well capitalized, so for right now, they’re fine.” The fact that the federal government invested a lot of money into the “preferred” stock, which gave the banks that measurement, should give us all pause for concern. Take that money out of the mix, and banks might not look so good. That “tangible equity capital” measurement – looking at the common stock alone – becomes increasingly important as this economy continues to free fall. Another huge downturn and some of those bigger players could easily become worthless without more federal intervention. But the government has already said that they are prepared to invest in the lowly common stock of appropriate banks, less than a controlling interest, to shore up the system. Isn’t that enough?

But what are these examiners looking for in this stress test? The February 25^th NY Times: “According to the new Treasury Department guidelines, the banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.” Although the government thinks these numbers are pessimistic, there are many serious economists who think they fit.

In any event, the rules for lending are clearly tightening just as the fundamentals required in order to get a loan are deteriorating. The Feds are going to make sure that enough solid banks survive (with all this bailout money, there will be several de facto nationalized banks no matter how they sidestep the label), but… What’s wrong with this picture?! Nobody has yet to explain how solidifying banks is actually going to generate loans to the businesses and people who need it most. While the government is “stress testing” away, the passing of every day eliminates another vast category of possibly qualified borrowers.

Bottom line: the government is going to have to give the banks the direct lending capital with lower qualification standards (but not too low to precipitate another subprime collapse) at first to jump start the moribund credit market. The President told us that we will get out of this mess, and they will unfreeze the credit markets. But no one, I mean no one, has explained to the American people exactly how that is going to work. As time passes, as we play with labels, we die a slow death. I am so stressed out!

I’m Peter Dekom, and maybe I just worry too much.