Dis’ Stressed to the Neins

In my recent Write On, Write Off blog, I drilled down on the banking elephant in the room: Piles of toxic (damn… there I go again, I meant legacy) assets (mostly aggregations of seriously underperforming mortgages and other questionable bank loans) that are carried on these bank balance sheets at values that are exceptionally difficult to justify in these harsh economic times. Banks argue that they will be worth more someday, when markets normalize, but government regulators and most of us lemons out here believe that denial is more than a river in Egypt.

When Treasury Secretary Geithner announced a series of incentives, primarily a series of risk-absorbing government loans, to help private investors buy these “legacy” assets from banks with prices determined in an auction, the stock market soared, but knowledgeable experts knew that a bank with lots of these assets carried at a high value could no longer sustain that value if the asset actually sold at a much lower price – reality for most banks.

So the big boys announced that there were financially sound, but for the most part they really didn’t want to sell those nasties into that even nastier pricing structure, which would effectively tank their balance sheets, impair their lending ability, reduce shareholder values and require massive new capital infusions, mostly likely from the lender of last resort – the government – and private investors goaded into investing with a combination of favorable government incentives and sheet jaw-boning power.

But we all know that there is a magical “stress test” being administered by the bank regulators – a combination of experts, mostly from the Office of the Comptroller of the Currency (which is part of Treasury), the FDIC and the Federal Reserve. They are admonishing smaller, weaker banks – yet to be “stress tested” – to sell their “legacy” assets sooner rather than later, but the smaller banks with bad assets either have already failed or are clearly on that path, so the bulk of those banks are not where the problem lies. The FDIC can move banks around and use its insurance funds to support depositors, a pattern which has worked amazingly smoothly.

The bigger “behind the scenes” news is that regulators are suggesting that the results of the initial stress tests – on the big banks – will be kept general and that information about specific banks will not be released publicly. Unfortunately for the banks, which are mostly publicly traded, SEC rules require a lot of disclosure in public filings. Even if they were not required to tell their shareholders of their dis-stress, what would you infer if out of 19 banks, five brag about how well they did on the test and 14 are silent?

It seems pretty obvious that there is a battle royal going on right now between the regulators and the most senior management of these banks. The replacement of GM’s CEO under government pressure is a lesson not lost on these banking giants. If they are in fact required to sell-off or even carry these legacy assets at the reduced values, the obvious capital infusion from the government will undoubtedly roll more than a few heads.

The very issue of executive compensation is also in the sights of Treasury officials, and which banker wants to submit to the destruction of these massive pay packages in favor of stringent, performance-based pay structures? The April 11^th NY Times: “‘This is a source of considerable consternation,’ said Camden R. Fine, who attended the White House meeting as president of the Independent Community Bankers, a trade group of 5,000 mostly smaller institutions, many of which are complaining about the repayment requirements.”

Somehow, if the regulators are truly seeking truth, one way or another, banks should be either forced to sell those “legacy” assets at auction or be required to carry them on their books at a vastly reduced and realistic value. That means a government infusion will most certainly be necessary, and with that infusion will be the “strings” that bankers fear. I remember FDIC head Sheila Blair’s statement, when the Treasury “loan for legal assets” program was announced, that the determination of which assets were going to be sold would be made “in consultation with the regulators.” Expect to see a bunch of new faces at the top of some of these big banks, with compensation packages that may anger American taxpayers a little less.

I’m Peter Dekom, and I approve this message.