Quick thoughts on the stress test and CAP
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I am on the road so I haven’t had a chance to fully detail our views or reflect on them relative to the equities. That said, here are quick initial thoughts on the stress test and CAP:
The underlying macro-economic assumptions of the stress test are not terribly “stressed”. They are more probable than unlikely:
* 0.5% GDP growth in 2010, after -3.3% in 2009 is now looking quite realistic
* 10.3% unemployment rates in 2010, after 8.9% in 2009. We have estimated, if government stability plans fail, the rate will rise to 11% in 2010)
* 7% declines in home prices in 2010, 22% in 2009 (They are down 18.8% y/y and 27% since 2006 peak, we have estimated a 2011 trough. Long term trends in home prices suggest that we will revert close to the peak levels of the previous cycle)
As a result, our initial expectation is that this will not be the last stress-test we run nor the last capital plan. This CAP plan will, like the other plans before, not resolve the problems with troubled banks. Instead, it will result in ultimately larger losses, larger Treasury issuance, larger deficits and several more weak and anticompetitive banks.
The terms on this also raise questions. I highlight two, as example.
- “Convertible in whole or from time to time in part at the Conversion Price at the option of the QFI at any time, subject to the approval of the QFI’s primary Federal banking agency.” – The investor doesn’t control the conversion, the issuer does! What kind of convert is that?
- “Notwithstanding the foregoing, if applicable, the dividend rate on the Convertible Preferred shall increase to 20% per annum on the sixth month anniversary of the issue date of the Convertible Preferred if the consent of the QFI stockholders described below has not been received by such date, and shall remain at such level until the date on which such stockholder approval is received.” – Is a contract under duress legal? It sounds like it is essentially saying “if you don’t have enough shares out to allow conversion we will charge you 20% until shareholders approve shares for their own dilution”.
- Nowhere does the plan define whether they will fill the capital hole in entirety or not nor does it define how the stress test will flow through to the banks capital needs.
- There are key capital valuation assumptions that are missing from the plan. How does a black box macro model flow through to the loss estimates? Ironically it seems we are continuing down the path that drove me to label this failed era in financial services – beginning to end – as “when models failed”.
They’ll almost certainly come back in 6 months or so for a third round run of this. In the meantime consider that last years Treasury net issuance of about $350 billion could increase above expectations of about $1.5 trillion to perhaps $2.2 or $2.3 trillion. It is enough to expect China, Japan and others to continue to purchase our debt. Will they quadruple or quintuple their purchases? What would happen if we had an undersubscribed auction? How long could we have a straw buyer bidding? What would happen to inflation expectations?
We have a viable banking system of 8500 banks. The argument that the top banks are the entirety our system of intermediation is not true, especially given the lack of capital market activity they drove through syndication, securitization and offerings. Let’s get on with it. Wipe out the bad banks today before we have to wipe out depleted government equity in those banks tomorrow. Body parts of the dead could provide life to the wounded.
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February 26th, 2009 at 7:45 pm
Your last comment caught my eye: 8500 banks.
Our government is not really going to respond to calls for openness and honesty. Did any TARP money go to foreign banks? Credit Suisse (Gramm)?
I think if you look back over the last twenty years of strong regional banks morphing into national monsters, I was in a region where it seemed a strong regional bank reportedly purchased by “Arabs” morphed with a Manhattan based bank. Perhaps it was their entree.
But no one is going to open up to Americans about foreign interests in the big ten banks.
February 27th, 2009 at 4:19 am
The banks are still getting access to an open-ended spigot of money to underwrite an open-ended hemorraghing of losses created by their own malfeasance. Fast forward 6 or 18 months with yet more $bn ($tn?) “invested” by the taxpayer and the institutions are still zombies recording huge losses . Sound pessimistic? No. Look at AIG right now. $150bn to date plus a $60bn loss to book, only 6 months after a bail-out whose cost prior to its Sept. credit event was supposed to be a mere $40bn. What does the government “own” at that 6 or 18 month point? What do we do with it? It can never be resold to the private sector. It is still “too big to fail,” only more so, since, in addition to the averred “sky is falling” economic fallout, it would be political suicide to let it fail and eat the taxpayers’ loss. The end game here makes a “lost decade” look good.
April 20th, 2009 at 4:10 pm
I want to give you credit. As a 20 year banker – I’ve talked with co-workers about “loans that didn’t look good, but everyone in the room with a little bit of brain knows it will pay” – so it gets approved vs. this loan is a piece of work, but it meets guidelines (usually written by someone at the secondary market) so it gets approved. So Joshua – based upon your comments – the latter appears to be the rule rather than the exception. HOW DO YOU KNOW THIS?
April 20th, 2009 at 4:24 pm
(sorry it posted unexpectedly) Where does this type of information exist? Did every bank in the USA turn on the stupid button/greed button?
Towards the end of the interview you touched on the need to re-establish trust in the rating agencies. I’ve been receiving job postings for a couple of months from the FDIC – and it’s all in-bred. The positions pay well – but they only promote from within. The same bozos as those at Fannie and Freddie – those making sure I initialed here, here, and here, and that the paperwork “looked” pretty, will only promote others of like mind. Where are the hands-on guys that can look at a book of business (like Me of course) and smell the “$$hi+” based on common sense? I also absolutley hate the generation of loan officers that believe that a FICO score is holy. All of the Credit Bureaus should have to document profits/fees charged, and provide the public with the real reason for their existence – CASH – They predict the obvious for any lender, again, with common sense. 8500 banks still to be touched by loan portfolios FILLED with FICO/Beacon/ETC.. scores deemed “golden” by the experts.
Help me amigo! Give me some real world support to your statements – help me find some banks where Officials said that you need a down payment to buy a $250,000 house. You can’t finance this car for longer than 60 mos. You’ll have to pay a higher rate than the bank/cu charges down the street, because we’ll be open next year.
Thanks!