Results of the Stress Test Leaks Out
The announcement of the result of the bank stress test has been delayed. Originally set to be released on May 4, the results will now be released on May 7th 5PM. The market is rife with speculations and rumors about which banks passed the test and which banks “failed” it. Among the banks that reportedly need more capital include Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), Regions Financial (RF), and SunTrust (ST). These leaks are not really surprising since it is difficult to test 19 of the nation’s biggest bank and keep the results secret.
The five banks are negotiating with regulators about the amount they need to raise to pass the stress test. In short, they are trying to convince regulators that they are better-capitalized than they really are. Right now, it is still unclear just how flexible the regulators will be in accommodating the banks’ request. It was reported though that the banks are actually trying to convince them to use first-quarter 2009 earnings to forecast the stress test results for the next two years. This further undermines the credibility of the said test which has already been criticized for not being “stressful” enough in projecting adverse economic movements in the future.
A lot of banks have strong first-quarter 2009 performance not because of the strength of the market and their own capitalization. Rather, it was because of the near-zero funding cost as well as the increase in refinancing due to the income from fixed-income trading and record-low mortgage rates. Although this trend is expected to continue over the short term, it is unlikely to remain that way for the next two years.
This is because once the Federal Reserve sees inflation, it will stop or significantly slow-down its purchase of mortgage-backed securities. It will also raise its rates to minimize the inflation. In addition, banks have benefited from the AIG payout in the first quarter.
Why Should the Public Care About the Stress Test?
There are many reasons why the public should care about the stress test. Previously, bank regulators have operated in secrecy. They justified that if they announce the details of the banks’ actual health, the public might pull out all deposits in panic. But this type of secrecy actually resulted to the destabilization of the whole financial system. Secrecy shielded bad decisions from being made public and thus it helped spur the collapse of the market.
In addition, the public has a stake in the back-room negotiations between the banks and the Treasury. With the Treasury injecting trillions of dollars into the system, the public need to know if taxpayers have the right representation in these major banks. Currently, the CEOs and the board members who had bought such disaster on the market is still in power, there is little reason to believe that they will change their tactics unless the Treasury convert its stake into voting shares.
The stress test is minimizing the benefits banks enjoyed from secrecy in the past. By bringing their lack of capital and real financial state into the public’s view, depositors and investors alike will be empowered in making the right choice.
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