STRESSed Out

The Wall Street Journal tells us what we already know and what I blogged about on April 16^th: there’s lot less bank lending going on right now than there was at the time that prompted the TARP infusion into lots of banks, an infusion that was supposed to unfreeze the credit markets. It’s global cooling in the credit markets by any measure, reflected by the rising tide of the unemployed who used to work for companies that required credit flow to operate. Yet, we are seeing one bank after another report “improvements” or outright profitability at a time when they aren’t really doing much in the way of business.

Sure they can borrow money from the Federal Reserve at close to zilch, and so any interest they earn when they make loans is wildly profitable, but what is it about all those profit or “income improvement” pictures that just plain makes me, and lots of financial analysts, feel so uncomfortable. Why don’t I believe that these banks have turned the corner and are out of the woods? Why do I think that the bear market rally that we saw last week was based on false hopes and shoddy accounting practices? What happens when truth slips through as it seemed to be doing on Monday, April 20^th? As earnings reports were shakier that we thought? Look at the precipitous market fall on that day. Not pretty, huh?

The April 20^th theDeal.com: “[A] number of large banks -- J.P. Morgan Chase & Co. (NYSE:JPM), Wells Fargo & Co. (NYSE:WFC), Goldman, Sachs & Co. (NYSE:GS), even benighted Citigroup Inc. (NYSE:C) and Bank of America Corp. (NYSE:BAC) -- reported earnings above estimates. Now let's face it: That could be a massive charade, hence the Enron meme, and Citi and BofA, in particular, are not close to being out of the woods. Or it could be, as the administration argues, that there's differentiation going on naturally [defensive bragging to prevent investor panic], which the stress tests may fuel. The only conclusion that [theDeal.com editor, Robert Teitelman] will put forth even tentatively is that the situation remains deeply ambiguous. Numbers can lie, on the upside and the downside.” Skepticism remains quite justified. But what do we know now?

I already described the “push-pull” of regulators not wanting banks to repeat the sins of the past and lend to the unqualified (but isn’t everybody, just about, unqualified in such a down market?) while the government extols banks to open the credit faucets to consumers and small business. But May 4^th approaches – the day that the federal “stress test results” are supposed to be final for the 19 largest U.S. banks – and there are lots of toxic assets ($2 trillion according to the prestigious McKinsey consultancy) on the balance sheet of banks that will produce some very unpleasant surprises. Exactly who has how much poison? Who will the government deem insolvent (or shored up with false assets on a manipulated balance sheet)?

Since the government is only in phase one of the stress analysis, which only covers the biggest of the bad boys – the next stress test will follow with the next tranche (one size down) of banks – we most certainly are not going to get a complete banking picture any time soon, although there are number of theorists who believe that massive holdings of toxic derivatives are unlikely scenarios for the smaller banks, except to the extent the little boys have not been able earlier to sell off their loans, which now fall into the non-performing or vastly-under-performing categories.

So what’s a government to do? Replace a portion of the toxic asset base with a deemed U.S. government equity position in the bank? Who else would make such an investment if not the government? Congress won’t appropriate more funding now, so the government would have to swap “equity in the bank” for the “deemed value” of the toxic asset. Treasury has created a program, subsidized with federal loan guarantees, for private investors to buy such assets, but only at auction-set pricing. That pricing won’t help a lot of banks, and hence the government is the only player able to move directly into those lending institutions. It might be the only thing that keeps more than a few of our national banking “treasures” from going under. And if the biggest banks were to fail without government intervention, there seems to be a growing consensus that the capital markets – and hence our economy – would drop below the unthinkable.

But if the government does step in – as many believe it must – aren’t we effectively “nationalizing” those banks, even if only on a temporary basis (until the government ownership position can be flipped back out into the market when times are better)? Should we be scared by a word like “nationalization” (even if we can create some harmonious synonyms)? Doesn’t this really deepen the federal deficits no matter what we call it, fuel inflation and infuriate taxpayers? In the end, it’s going to be a judgment call, and whatever the decision – let the banks fall to whatever level they deserve or we will support those banks with the greatest impact on our nation’s recovery – it will be wrong and it will be right. Detractors will be justified, because there is no way to ascertain what really would have happened if the opposite choice were made.

If the bad boy bankers riding those wild hogs are stressed, at least they’ve made their pile off the sweat of the aggregation American workers we call the economy. It’s okay to be stressed while being stress-tested when you’re well paid, but when that stress, which has already been inflicted on the rest of us who might not have drawn those big corporate checks, comes home to the average American household, we have nowhere to turn to except to our elected representatives… and God.

And if you think the situation is bad, so does the IMF, as noted in the following excerpt from an Associated Press article by Jim Kuhnhenn on April 21^st: “Treasury Secretary Timothy Geithner defended the bank rescue program devised by the Obama administration [April 21^st] as the International Monetary Fund predicted U.S. financial institutions could lose $2.7 trillion from the global credit crisis.” Although avoiding the blunders of blind and non-accountable distributions of cash from the early use of TARP is critical, the rolling passage of time without movement in the credit markets could be even more devastating. At some point, unplanned bank failure will become the “decision absent a formal decision,” and those cards will fall.

I’m Peter Dekom, and there goes another night of lost sleep!