Of the many issues that arise via the banking bailouts we have seen, perhaps the most pernicious is how corrosive the process becomes. It corrupts even the most well intended parties.

The latest example is the stress tests, which run the risk of being window dressing. As noted last week, the Stress Tests themselves weren’t very stressful. And, now that some of the results are coming in, the cure for inadequate capital is not more capital, but an accounting trick — converting preferred stock to common. As Paul Kasriel of Northern Trust describeed it, this amounts to nothing more than Accounting Alchemy — the finacial equivalent of lead into gold.

Thus, we see the major test for the sector was inadequate to cleanly identify potential weakness. And even by that soft standard, the cure is inadequate.

US banks are suffering a solvency problem, and what they need is more capital, not an accounting sleight of hand. Yet that is precisely what they are getting — the same clever financial engineering that led to the crisis in the first place. All Treasury needs is more leverage and a few derivatives and the transformation into the financial Borg will be complete.

From Bloomberg:

“At least six of the 19 largest U.S. banks require additional capital, according to preliminary results of government stress tests, people briefed on the matter said.

While some of the lenders may need extra cash injections from the government, most of the capital is likely to come from converting preferred shares to common equity, the people said. The Federal Reserve is now hearing appeals from banks, including Citigroup Inc. and Bank of America Corp., that regulators have determined need more of a cushion against losses, they added.

By pushing conversions, rather than federal assistance, the government would allow banks to shore themselves up without the political taint that has soured both Wall Street and Congress on the bailouts. The risk is that, along with diluting existing shareholders, the government action won’t seem strong enough.”

All this goes to show is that receivership was the correct approach to this in the first place. Instead, we get “Gentleman B” stress tests and nonsense accounting gimmicks. The Treasury and Federal Reserve can no longer be considered honest brokers of the process. They too have been corrupted by the ugly process of rationalizing insolvent banks ongoing existence . . .

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Turning the Corner?
corner
via Dan Wasserman

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Previously:
Stress Test: Not Very Stressful (April 24th, 2009)

http://www.ritholtz.com/blog/2009/04/stress-test-white-paper/

Sources:
Fed Is Said to Seek Capital for at Least Six Banks
Robert Schmidt and Rebecca Christie
Bloomberg, April 29 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=aiz06xRmmeOQ&

Preferred Equity into Common Equity – Accounting Alchemy?
Paul Kasriel
Northern Trust, April 27, 2009

http://web-xp2a-pws.ntrs.com:80/content//media/attachment/data/econ_research/0904/document/ec042709.pdf

See Also
Time for Bank Creditors to Share the Pain?
DAVID LEONHARDT
NYT, April 28, 2009

http://www.nytimes.com/2009/04/29/business/economy/29leonhardt.html

Category: Bailout Nation, Bailouts, Credit

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

42 Responses to “Ugly Process: Rationalizing Insolvent Banks Existence”

  1. snapshot says:

    http://voices.washingtonpost.com/hearing/2009/04/fools_rush_in_to_ease_mark-to-.html#more

    Guest post @ The Hearing by Joe Peek – University of Kentucky

    “Fools Rush in to Ease Mark-To-Market Rules”

    “As financial commentator Abraham Briloff famously noted, financial statements are like fine perfume: To be sniffed, not swallowed.”

  2. sfharris81 says:

    Perhaps some in government agree with you that another approach should be taken but I think that the real lesson learned was the collapse of Lehman Brothers and the chaos that resulted in the aftermath. The lesson is that the financial markets cannot handle nor rationalize a failure of that magnitude. If Lehman with a $600 billion balance sheet caused so much fear, panic, and chaos what would happen if a near $2 trillion Citigroup were allowed to “go.” At this point it is unthinkable. The government has chosen and will stay on the path of “stealth liquefaction” or whatever you want to call it. This is no secret, the Fed Chairman came on 60 minutes some time ago and addressed the nation on this point. The beast(s) will be proped up.

  3. Bruce in Tn says:

    GDP this morning will be?

  4. snapshot says:

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aqtmeiUmp8ug&refer=home

    “Bank of America CEO’s Support Erodes Ahead of Meeting”

    “Lewis’s future is probably out of his hands at this point,” said Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, California-based research firm that tracks banks. “The time for Ken Lewis to hang tough was when he could have told the government, “No, I won’t buy Merrill Lynch, he said.”

  5. “All this goes to show is that receivership was the correct approach to this in the first place. Instead, we get “Gentleman B” stress tests and nonsense accounting gimmicks. The Treasury and Federal Reserve can no longer be considered honest brokers of the process. They too have been corrupted by the ugly process of rationalizing insolvent banks ongoing existence . . .”–BR, above

    “The Treasury and Federal Reserve can no longer be considered honest brokers of the process.”

    That, to me, is the most difficult Pill to swallow. Sadly, avoidance of the bitter Medicine allows the Disease to continue to metastisize.

  6. Mike in Nola says:

    Barry, don’t you know there’s nothing fundamentally wrong? It’s all a crisis of confidence that will be solved if we can help them oveer the rough spots.

    Krugman’s comment about the banks wanting to get back to business as it was in 2007:
    http://www.nytimes.com/2009/04/27/opinion/27krugman.html?_r=1&partner=rssnyt&emc=rss

    Bruce: Most likely it surprises to the upside all the money pumped in could raise figures, even if not doing anything useful. Earnings reports world over are bad, but the headline is that they are beating expectations.

    Obviously, Citi is doing well enough to pay bonuses and to try to get it’s energy trading unit away from the Feds. We have nothing to worry about.
    http://www.cnbc.com/id/30466355

  7. Mike in Nola says:

    Bruce: Didn’t mean it would actually be +. Just that it may not be as bad as expected, much like consumer confidence.

  8. danm says:

    Consumer confidence is a joke.

    Of course, they are happ. They can finally stop spending as much as they were and start saving since that’s what all the Joneses are doing also. What a relief!

  9. zachstocks says:

    I have to disagree with you on the “accounting gimmicks.” Converting preferred stock to common stock actually changes the balance sheet picture. It completely erases this capital from the LIABILITY side of the ledger while maintaining the infused cash as an asset.

    The problem is not the gimmick, but the dilution to current shareholders. At this point I would rather be a bond holder than a stockholder with the way the government is re-writing the rules. But at the same time, there is nothing to say that the rules for bond holders couldn’t be re-written farther down the road.

    I wrote a piece on this conversion (preferred to common stock) that may be interesting: http://zachstocks.com/2009/04/tarp/

    Good food for thought. There is no easy way out of this.
    Zach

  10. snapshot says:

    Mark E. Hoffer – I feel like we are right back to where we were 200 plus years ago.

    “No taxation without representation.”

    Who the hell is looking out for us? Treasury and Federal Reserve “can no longer be considered honest brokers of the process” and our elected officials have failed us completely. They have done away with any laws that were in place to protect us and are supporting the continued folly of the securitization model.

    Receivership was the correct approach. Where are we headed now?

  11. Bruce in Tn says:

    Couldn’t we just rename the FED and the Treasury “Nation’s Bank” and let the motto be “No Debt too Big to Fail?”

    http://www.nytimes.com/2009/04/29/business/economy/29housing.html

    A New Plan to Help Modify Second Mortgages

    “WASHINGTON — The Obama administration sought to expand its $50 billion plan to reduce home foreclosures, announcing a new program on Tuesday to help troubled homeowners modify second mortgages or piggyback loans.”

    I guess I don’t understand why this might not be such a good idea…I mean after all, April 15 th has already come and gone…

  12. Transor Z says:

    GIGO

  13. call me ahab says:

    BR Says:

    “The latest example is the stress tests, which run the risk of being window dressing. ”

    BR- it IS window dressing intended to manipulate public perception- we already have institutions which monitor bank health- the Treasury is using the stress tests to be able to to say to a naive public: “jump in, the water is fine”-

    the failed TBTF banks need to be nationalized, rightsized and sold off- they brought on their own misfortune- and they will need to be propped up for years to come otherwise and will never regain the complete confidence of the American people.

  14. call me ahab says:

    GDP down 6.1% – whew!- jump in- the USG is in great shape

  15. dead hobo says:

    BR observed:

    And, now that some of the results are coming in, the cure for inadequate capital is not more capital, but an accounting trick — converting preferred stock to common.

    comment:
    ———————-
    You’re pissing in the wind. Nobody cares, at least nobody who has the power to control the transaction. Perhaps the Fed or FDIC could issue a statement that proclaims preferred stock may be considered capital if issued in an emergency rescue situation. Then they wouldn’t have to go through this charade.

    There’s a lot of dishonesty being used to repair a situation created by dishonesty.

    Breaking news CNBC … GDP (ADVANCE) (red down arrow) 6.1% . Visually, to a retard, the graphic make it look like GDP went up 6.1% because the word ADVANCE is so prominent. Stock index futures are up even more, so the retards are out in force.

  16. snapshot,

    this: “Who the hell is looking out for us?” is a good Q/is more of the same disease.

    We need to Remember: “Some things cannot be Outsourced”

    and, impolitic in this JIT-world: “Outsourcing makes you Slave to your supplier..”

    “JIT (also known as lean production or stockless production) should improve profits and return on investment by reducing inventory levels (increasing the inventory turnover rate), reducing variability, improving product quality, reducing production and delivery lead times, and reducing other costs (such as those associated with machine setup and equipment breakdown). In a JIT system, underutilized (excess) capacity is used instead of buffer inventories to hedge against problems that may arise.”
    http://personal.ashland.edu/~rjacobs/m503jit.html

    or, differently, “Trade, by Choice, is Liberty. Trade, by necessity, is Slavery.”

  17. dead hobo says:

    OR, how about …

    Breaking News. GDP falling at a slower rate. Everything is good.

  18. Transor Z says:

    Investors find reason for optimism as the GDP slowed its decline in the first quarter of the year. Although GDP estimates were overly optimistic by more than 25%, the fact that GDP shrinkage was .2% better than last quarter is a very positive sign.

  19. Transor Z says:

    Ministry of Truth here I come! :)

  20. call me ahab says:

    Transor Z-

    wow- that’s quite the spin

  21. Onlooker from Troy says:

    Re: GDP, from Yahoo:

    “The consensus estimate calls for an annualized decline of 4.7% from the prior quarter as business components are expected to cause a drag, but consumer spending is anticipated to provide support, despite rising unemployment. Overall, any number that is better than the 6.3% decline registered in the fourth quarter should help the view that the economy is in the process of bottoming.”

    Good grief. The whole world’s brainwashed into thinking that this market is currently priced for Armageddon and anything that shows we aren’t in absolute free fall should be a positive and make the market go up.

    And the idea that consumer spending is going to save this ship is just UFB. If the consumer is spending at increased levels then they have truly been duped again. There’s no way is can be sustained! Hasn’t that been well established!

    So the number comes in at -6.1 and futures still show a pop up at the open. How can anybody possibly believe we’re still looking at a 2nd half recovery and thus that the market should be priced for earning growth in the near future, much less the kind of multiple it’s at right now????

  22. Onlooker from Troy says:

    Better than expecte, worse than expected. It doesn’t seem to matter now in this alternate universe the market is in. Truly fascinating and puzzling. This bear market rally psychology stuff is amazing.

  23. Transor Z says:

    Next question: what does annualized GDP growth need to be in Q2-Q4 for the stress test “adverse scenario” of ~ -2% to remotely resemble reality?

  24. Onlooker from Troy says:

    You’ve got to believe that the bump up in consumer spending is just a result of the sharp reduction in Q4. If spread over both quarters we see roughly -2%. Future quarters will show the negative trend, IMO.

    I’m not an economist, is that sound reasoning?

  25. DMR says:

    Mark,

    JIT is a conservative manufacturing approach that reduces waste and inefficiencies. Supply chains have been around and been managed since the day that the first caveman delegated the job of chopping wood to another caveman. As for “outsourcing”, the recent media hoopla about outsourcing failed to mention that it is again a concept that has been around for millenia. When specifically talking about call center outsourcing, the first wave of aggregation of various call centers resulted in centralized operations in Texas that may have replaced jobs in various small local operations centers. Frankly, to most of us, the choice between a Texas accent and an Indian accent wasn’t that big a deal. Agreed, losing the local banker’s voice is a big deal, and there currently is no good solution. Whether the central operations centers of the big banks is in Texas or India, they can’t offer me the level of service or relationship that my local savings bank can. But, that is par for the course when you deal with a big bank.

    Is it possible that in your rush to find a scapegoat for corrupt financial practices and greed, you are picking on the one sector of the US economy that is actually more efficient than the rest of the world? Folks who actually do work for a living getting picked on by paper traders on wall street? How novel!

  26. HCF says:

    Wow… -6.1%

    Put those green shoots in your pipe and smoke it…

    HCF

  27. dead hobo says:

    Transor Z Says:
    April 29th, 2009 at 9:00 am

    Next question: what does annualized GDP growth need to be in Q2-Q4 for the stress test “adverse scenario” of ~ -2% to remotely resemble reality?

    reply:
    —————-
    HA Ha. That’s a trick question. First you need to agree on the definition of ‘reality’ and assign it to a fixed point in time. Then your answer need to be based on that reference point. Then, everybody gets to ignore all your work since the definition of ‘reality’ changes regularly. My recommendation to you is to use the definition of ‘reality’ that is used by the biggest dog in the room. Why shoot yourself in the foot.

  28. Todd says:

    Thats less than the revised 4th qtr. Original came out at 6.1 or 6.2. This number will be futher revised up to 6.2 or 6.3 as well.

    MSM is saying mostly due to inventory levels falling. Just wait all of those cars being sold and not replaced since GM will be shutting down for 9 weeks. Inventory has further levels to fall.

  29. DMR,

    yes, I know. As I said, it’s ‘impolitic’. JIT, in, and of, itself, can be a great tool. Like many things, it’s “how it’s applied”.

    It has been radically over-Financialized. What, once, led to increased Organizational Operation Efficiencies, now, leaves most too brittle to withstand any disruption, let alone ‘shocks’.

    A similiar thing has been done to Balance Sheets, in the name of ROI..

    all predicated upon the Fallacy: “underutilized (excess) capacity is used instead of buffer inventories to hedge against problems that may arise.” (on the Balance Sheet side, “Equity” was the “Inventory” replaced..)

    we forget that Trade/Liquidity is the exception, not the rule..

  30. Onlooker from Troy says:

    Here’s another amusing (in a tragic sort of way) thought on PCE. So many people have reached the tipping point, they’re going to default and go bankrupt or get foreclosed on anyway, they stop paying the bills but go on one more splurge with the credit cards before it’s too late. They feel no moral compunction about screwing the banks given the environment we’re in. Of course that will just lead to more defaulted debt.

    It’s unfortunately a plausible thesis. The skeptic in me needs to find a reason for increased PCE in this economy. The consumer is tapped out. We know that.

  31. Transor Z says:

    @DH:

    First you need to agree on the definition of ‘reality’ and assign it to a fixed point in time. Then your answer need to be based on that reference point. Then, everybody gets to ignore all your work since the definition of ‘reality’ changes regularly. My recommendation to you is to use the definition of ‘reality’ that is used by the biggest dog in the room. Why shoot yourself in the foot.

    Funny and wise. :)

  32. dead hobo says:

    Financial Advice For The Elderly And Significantly Infirm ….

    If you are in a position where you, statistically, don’t have many much longer until you move on to your celestial reward, then think of yourself as someone with a golden ticket.

    If you still have credit cards, then load them up. All of them. To the max. Get whatever you want and don’t deny yourself anything.

    Then, make the minimum payment, on time. Use cash advances if you have to. Keep it honest until the date you make the final move out of their jurisdiction. Last tag. You win.

  33. snapshot says:

    I wonder if the reason the consumer is not falling off a cliff is due to the refinancing taking place.
    How long can that last? Those who had the equity and wanted the lower rates have probably already jumped in. No raises. Stricter rules/ higher rates on CC. How are higher consumer numbers sustainable?

  34. “…the finacial equivalent of lead into gold.”

    Pretty much sums up the last decade, from at least 1998′s LTCM bailout ’til now. Krugman’s piece was dead on–how have the financiers added value to anything? The lead is still lead, no matter how clever are your financial machinations to the contrary. Lead is lead, even when the biggest dog in the room says otherwise. Reality is a bitch that can take a lot of slapping and still be a bitch.

  35. zot23 says:

    This has gotten so bad even they can’t pretend it makes sense anymore.

  36. constantnormal says:

    Say, Barry, I know this is a bit off-topic, but do your tech folk have any idea how the bots are getting past the WordPress signup filters?

  37. constantnormal says:

    @ Mike in NoLa 8:03

    re: GDP –

    “Most likely it surprises to the upside all the money pumped in could raise figures, even if not doing anything useful. Earnings reports world over are bad, but the headline is that they are beating expectations.”

    So now that it turns out differently, what do you think that says about the direction we are moving in? hmmmmm?

    I guess we need a government-administered stress test for the GDP, so we can put a rosy face back on things, and continue to see green sprouting everywhere instead of the gray of the recently deceased.

  38. Stuart says:

    “The Treasury and Federal Reserve can no longer be considered honest brokers of the process.”

    Detached skepticism, necessary for effective governance over the banks cannot be possible when the Fed and the Treasury are instead lead by interested men.

    Useful terms.

  39. Stuart says:

    The question is does the Fed announce an expansion to its QE efforts this afternoon.

  40. batmando says:

    How many times we gonna test 870?
    High / Close
    4/16 870.35 / 865.30
    4/17 875.63 / 860.87
    4/24 871.80 / 866.23
    4/29 874.02

    Andy T?

  41. WSJ Staff says:

    The government confirmed the following list of the 19 banks undergoing stress tests:

    J.P. Morgan Chase & Co.

    Citigroup

    Bank of America Corp.

    Wells Fargo & Co.

    Goldman Sachs Group

    Morgan Stanley

    MetLife

    PNC Financial Services Group

    US Bancorp

    Bank of NY Mellon Corp.

    SunTrust Banks Inc.

    State Street Corp.

    Capital One Financial Corp.

    BB&T Corp.

    Regions Financial Corp.

    American Express Co.

    Fifth Third Bancorp

    Keycorp

    GMAC LLC

  42. [...] are not going to pay us back anytime soon Jump to Comments Big Picture: “At least six of the 19 largest U.S. banks require additional capital, according to preliminary [...]