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Tuesday, May 5, 2009

"Manageable Losses"?

The financial world seems upside down to me. On the day it was leaked that Wells Fargo, Citigroup, and Bank of America had failed their stress tests each of their stocks was up. The market was up nearly three percent. That day, the leak said that six banks had failed their stress tests. Today, that number rose to ten and the market was down just slightly.

To me, it appears that the market and everyone near it is trying desperately to spin any news as good news. While these stress tests were still being administered, most analysts cried foul. The going narrative was that the stress tests were designed to be too easy to pass in an attempt to cover up for bad news. Now that more than half have apparently failed, the new narrative is that the losses are "manageable".

US regulators are working with the top 19 banks on Tuesday to put the final touches on the results of regulatory stress tests, which are expected to reveal about half the banks need more capital but face manageable losses.

How manageable are the losses though? After all, we've already poured three quarters of a trillion dollars into the banking system. We have set up a plan to remove their so called "toxic assets" at above market prices. Yet, half of them still need more capital. Are these losses really "manageable"?

Then, there is the stress test itself. It hasn't been released but what has been leaked says that they ran the test as though unemployment was at 10.3%. This was supposed to be the worst case scenario. Unemployment is now 8.6% and after Friday it will likely be about 9%. We should reach just over 10% by about September. Would it really be shocking if our overall economic picture was soon enough worse than an unemployment rate of 10.3%? If so, how many banks would fail then?

There's yet another part of this that makes no sense.

The results—due to be unveiled on Thursday—will likely show that the largest U.S. banks do not need dramatic new government interventions, which could further drive the recovery of banks' stock prices and signal an exit strategy for the government's intimate involvement in the sector.

Keep in mind that ten of the nineteen banks will be required to raise billions in new capital. Well, no one in their right mind in the private sector will give them any money. So, they will have to come to the government. It's even possible that many will convert preferred stock into common stock. So, how exactly will this end the government's "intimate" involvement with the banks?

It's like we are in an alternative universe where all bad is really good. Stress tests that no one should have failed were failed by more than half, and this is good news? Then, everyone will have to rush back to the government for more money, and this is a sign the government is done with their intimate involvement with said banks. I think everyone is deluding themselves. Of course, the problem there is that we all face reality at some point.

1 comment:

Anonymous said...

Man, and I was all set to short the market on Friday when nonfarm payrolls come out. Now I'm not even sure the market will interpret *that* negatively.