Stressing to the finish line

Business Times - 07 May 2009

Stressing to the finish line

But Bernanke seems to have reassured markets that US bank stress test results won't have big surprises


THE 19 big US banks' stress test results are set to be finally made public by the Treasury Department after the financial markets close today in New York (early tomorrow morning, Singapore time). And Federal Reserve chairman Ben Bernanke, addressing Congress on Tuesday, tried to calm the markets by downplaying the possibility that the government would ask Congress for a new infusion of taxpayer money into ailing banks.

In fact, the Treasury Department and the Fed began releasing information about their stress test on major banks by providing the banks with the preliminary results 12 days ago.

The Fed also released its methodology ahead of a public announcement of the results. It indicated that the banks had to run their portfolios against assumptions about the potential for worsening economic conditions, including rising unemployment and falling house prices, and to make predictions about how that would impact the value of their holdings.

But the stress results that had been scheduled to be released on Monday were pushed back under pressure from bank executives who were trying to persuade the federal government to improve their 'grades'.

According to reports leaked to the press, the stress results show that while reserves had substantially shrunk in some banks, most had capital well in excess of government standards.

The 19 banks examined hold about two-thirds of the assets and more than half the loans in the US banking system, and the disclosure of the test results is bound to have a major impact on public perception - including that of the markets - on whether the financial system is on the way towards recovery.

If the test results are seen as credible by the markets, it will put pressure on those banks that are undercapitalised to raise new capital, while freeing up those who receive a clean bill of health to restart lending, creating the conditions for the end of the credit crunch and for economic recovery.

One of the main reasons for the delay in the release of the stress results are disagreements between some banks and the government over the assumptions being applied to forecast the banks' revenues in the next two years, with the banks insisting that they were going to have higher revenue than the government was forecasting.

Some reports say Wells Fargo, Bank of America and Citibank will be forced by the government to raise new funds.

Treasury Secretary Timothy Geithner ordered up the stress tests three months ago as part of an effort to demonstrate to Congress and the public that the original US$700 billion bank bailout, the Troubled Asset Relief Program (TARP), was working. And in case banks needed more capital, the test results were supposed to convince lawmakers to give them more taxpayer money.

'While I know there are many critics of the TARP, I do believe that availability of that capital helped us dodge what would have been a truly cataclysmic collapse of the global banking system,' Mr Bernanke said on Tuesday. 'I think we've made a lot of progress.'

The problem is that neither Congress nor the public is in the mood to give the banks more money. Hence, much of the discussion in Washington and on Wall Street in recent weeks has been focused on finding alternative ways to help the banks other than using taxpayer money. In that context, top White House economic adviser Lawrence Summers proposed the idea of using asset liability swaps and converting debt into equity as alternative means to raise capital for banks.

In a way, a major obstacle to restoring the health of the financial system has been the risk involved in the uncertain valuation of the toxic assets, aka troubled assets or legacy assets which are responsible for the banks' bad balance sheets. As Columbia University economics professor Joseph Stiglitz suggested during a discussion on the Charlie Rose Show, the main problem now is 'who's going to bear the risk of uncertain valuation?'

Under the original plan proposed by former Treasury secretary Henry Paulson, the federal government was supposed to buy these toxic assets, while the current revised programme shifted that responsibility to the private sector with the added guarantee of the federal government. By converting the debt into equity, the responsibility shifts to the bondholders who would be rewarded if the legacy assets are worth more than currently estimated - but who would suffer losses if they are not worth a lot.

In any case, Mr Bernanke during his testimony on Capitol Hill before the Joint Economic Committee insisted that the results of the tests would not offer major surprises.

'I've looked at many of the banks and I believe that many of them will be able to meet their capital needs without further government capital,' he said. He explained that most of the undercapitalised banks could raise new capital through 'either issuance of new capital or through conversions and exchanges or the sales of assets and other measures that would raise capital'.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


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