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Geithner's "Stress Test" for Banks, and a Stress Test for America
The only way to make sense of Tim Geithner’s “stress test” for banks is to assume a kind of triage. Banks that are reasonably healthy right now -- whose assets are fully adequate to fund their liabilities, and can make new loans -- don't need a bailout. And banks that are too far gone to save –- whose loans when realistically valued won’t make them solvent even when the economy recovers -- shouldn't be bailed out. They should be put under receivership that pays off depositors, wipes out shareholders, and then closes the bank.
This leaves a third category of bank that could be salvaged -- whose assets are likely to be enough to make them solvent when the economy turns up again -- but that need bailouts in the meantime. Money from the Treasury and Fed will be used to lure outside investors to buy up these banks' bad loans and clear up their balance sheets so they can make new, responsible loans.
At least, that's the only sense I can make of it.
But how much of our financial system falls into the “too-far-gone-to save” category, and how much into the “might be saved with taxpayer help?” And how will Geithner and his colleagues at the Treasury be able to tell? After all, we got into this mess because banks were fiddling with their numbers and making bets off their balance sheets. And most still aren’t willing to write down their bad loans to realistic market values.
It would be far cheaper, quicker, and safer for the government to just take over every questionable bank. This is the only way we can get the truth about which should be shut down. And the way taxpayers who will be bailing out salvagable banks can ever recoup our costs. Why should any upside gains go to private shareholders who made bad bets or to bank executives and directors who got us into this mess in the first place?
Meanwhile, the rest of America could stand a stress test on a much bigger scale. No need to worry about families with adequate assets to get them through the storm. And the stimulus will help many others. But families that have lost their savings and are within a few years of retirement, or whose breadwinners have been out of work for months and have exhausted their unemployment benefits, or have no health insurance, or who are on the verge of losing their homes – may not make it. Instead of rewarding executives of insolvent banks that would otherwise fail, we should be helping insolvent families for whom failure spells disaster.
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When Lindsey Graham opines on national Sunday news
that he thinks we should be looking at nationalizing the banks I get scared.
That would be like finding an old speech of John C. Calhoun calling for the abolition of slavery.
You have always stood up for the powerless.
But I am starting to get scared. This is a real mess. And you and Krugman and so many other economists who have not 'sold out' have got to be heard!!!
I could be way off, after all, what do I know. But I foresee many other programs down the pike. This New Administration did not come all this way to chicken out.
February 16, 2009 5:42 PM | Reply | Permalink
Great, and I thought Sen. Butters was giving Obama cover to do the right thing. But your probably right I'm letting my guard down and thats when they strike. Wonder what the plan is.
February 16, 2009 5:59 PM | Reply | Permalink
Yup. Scary stuff. Financial. And political/psychological.
February 17, 2009 9:34 AM | Reply | Permalink
Always good to see you here.
Question: per the 'psychological' point you raise.
Don't you think that a lot of people need to go through some kind of 'grieving' process and say, 'wow, that life I thought I could grasp isn't in the cards, so now what?'
I sense that this is happening, but if it occurs while people see that the larger, more politically privileged (global) players don't have to pay any price and seem to have their made-of-fantasy lives continue unimpeded, then I think the social disruptions could be scary and severe.
I'm angry about the entire mess (still driving my old vehicle b/c I figured GWBush would completely maul the economy), so I resent underwriting other people's extravagance. But I can stand the thought of it as long as the fraud, lies, deceptions, and theft work their way out of the system PROVIDED that 'we're all in this boat together'.
When I see that I'm in a sinking dinghy, and Hank Paulson is off in his yacht, I have a hard time using civil words to express my utter loathing for a system this corrupt.
So if the bankers aren't accountable, then we'll have not only financial problems, we'll have more cynicism, despair, and utter seething contempt -- you have to manage the emotions, along with managing the money.
To manage the emotions, the bankers have to be at the front of the 'you just screwed yourself' lineup.
Am I mistook, TheraP?
February 17, 2009 3:07 PM | Reply | Permalink
cheaper, quicker, and safer
This is so intuitively obvious, that ongoing anti-nationalization pronouncements from Prez & Co. must be smoke...why yes, I believe I can feel it going up my ass even as I type...
February 16, 2009 5:48 PM | Reply | Permalink
. . . the only way we can get the truth . . . .
Given the competency and manning levels of Treasury, OCC, and FDIC that would come sometime around 2013?
February 16, 2009 7:48 PM | Reply | Permalink
"Instead of rewarding executives of insolvent banks that would otherwise fail, we should be helping insolvent families for whom failure spells disaster." Exactly Mr. Reich and this message critical.
Because while FAILED executives of FAILED banks will take a hair cut if the FAILED banks are justifiably nationalized, - they will still retire in opulent luxury the other 99% of America can never imagine.
On the other hand, the "disaster" Mr Reich describes for insolvent families translates into very real human visceral pain, suffering, deprivation, degradation, malnutrition, broken families, mental health issues, or worse.
Robbing and pillaging poor and middle class Americans to feed the predator class is reprehensible and immoral conduct that defines the gop.
Obama promised to give voice to the voiceless and to work for real change. Tragically, Obama's selections for his economic team are all predator class Wall Street insiders bent on bailing out their cronies and select oligarchs with taxpayer dollars and heaping all the terrible costs and imponderable debts on the shoulders of America's children. No change or giving voice to the voiceless will be advanced by any of these predator class advisors.
Your message, and others like Stiglitz, Krugman, and Simon Johnson must somehow be delivered to directly the President, because his advisors are certainly not working in the peoples best interests.
February 16, 2009 6:06 PM | Reply | Permalink
Citi is toast. That much I know.
February 16, 2009 6:23 PM | Reply | Permalink
How is your bank doing? You can find out by looking at the Texas Ratio.
Find your bank on this list of banks
February 16, 2009 8:07 PM | Reply | Permalink
There are a zillion banks on this list and they are NOT alphabetized. Did you know that?
Not helpful at all.
February 17, 2009 11:26 AM | Reply | Permalink
Thanks! It was easy to search for my bank (edit-find). Looks like it's OK.
February 17, 2009 12:14 PM | Reply | Permalink
Exactly
My admittedly imperfect understanding of what one of these "stress tests" is about, is that they are a mathematical models that project the range of risk in a given portfolio of assets under hypothetical, more extreme than a standard VaR, assumptions of market conditions.
I don't quite see how that concept applies to the present circumstances, where the chief difficulty seems to be that huge quantities of these assets are already unmovable because no one has any idea what they might be worth. We're not worried how much value they, and thus the value of the portfolio of the bank in question, might fall in some future hypothetical bad conditions, though Lord knows things could get even worse in the economy, because these things already have zero current value.
The problem is bad data quality on the assets, not the lack of the right model to plug asset values into. And the data quality is bad because many of these new investment instruments were designed specifically to be opaque to investors and regulators, and in some cases of underlying assets that we know about, mortgage originators systematically encouraged borrowers to lie about their ability to handle the mortgages being let.
So yes, the solution is to send in the bank examiners and the FBI to sort out the underlying valuations. The results of that process, honest data on underlying values, will tell us where we need to go from there.
February 16, 2009 8:27 PM | Reply | Permalink
What's so funny about the banks' ostensible valuations of all these toxic securities is that somehow each bank is sure that it is the only one whose portfolio is magically worth 90+ cents on the dollar. Everyone else's is worth 40. Even if it contains the same set of exposures.
(Which brings us to another good reason to put everybody into receivership and let the examiners sort it out: figuring out who owes what to whom. Right now if Bank A holds a billion dollars of worthless paper ultimately traceable to Bank B, and Bank B holds a billion dollars of worthless paper ultimately traceable to Bank A, the TARP response is to make them both whole by handing out two billion dollars. What would be nicer, where possible, would be to unwind all the trails of ownership and liability before doing anything else, so that any countervailing debts, including indirect chains of debt, simply vanish like the accounting tricks they are before anyone starts ponying up real cash to cover them. And you can't do that without acces to all the books.)
February 16, 2009 9:02 PM | Reply | Permalink
LaRouche: Only Enemies of the U.S.A. Oppose Bankruptcy Reorganization
February 15, 2009 (LPAC)--Lyndon LaRouche today reiterated his call for President Barack Obama to immediately declare a national and international financial emergency, and announce a bankruptcy reorganization of the entire Federal Reserve banking system. In his Feb. 11 international webcast, LaRouche had explained that nothing short of a top-down bankruptcy reorganization of the entire, hopelessly-bankrupt financial system, could stop the plunge into a global dark age, worse than the 14th century collapse of Europe.
LaRouche today added that ``the people who are responsible for this catastrophe are now the main opponents of my proposal for a top-down bankruptcy reorganization.'' LaRouche called on them to ``learn their lesson and come along, or just shut up.''
``We are in a breakdown crisis,'' LaRouche continued. ``My focus is on the urgent measures that must be adopted immediately, to save nations and economies from total ruin. The present post-Bretton Woods system is hopelessly bankrupt and cannot be saved. But that is not a problem. You can always create a new financial system, following a bankruptcy reorganization of the old, dead system. The simple fact is: Many bankers are going to have to eat the losses, especially those financiers who built up the approximately $1.4 quadrillion dollar derivatives bubble.
``There are people who are trying to save the derivatives swindlers, at the expense of current and future generations of American taxpayers,'' LaRouche charged. ``In my view, these people are thieves, who gambled criminally with other peoples' money. They lost, and nobody in their right mind can justify bailing them out, on the backs of working American families. But isn't that exactly what Hank Paulson proposed? Isn't that what Nancy Pelosi, Chris Dodd and Barney Frank are still proposing?
``I am very concerned that enemies of the United States, including some people who are trying to mis-advise President Obama, are blocking the urgently needed bankruptcy reorganization, that I first spelled out in my July 25, 2007 international webcast, and then issued in legislative form in the Homeowners and Banks Protection Act (HBPA).
``There is no alternative to the HBPA, if the United States and the world are to avoid a plunge into a dark age collapse,'' LaRouche concluded.
http://www.larouchepac.com/news/2009/02/16/lpactv-weekly-update-02-16-09.html
February 16, 2009 9:24 PM | Reply | Permalink
I'm sure glad LaRouche has a plan, I was starting to worry.
February 16, 2009 9:27 PM | Reply | Permalink
What really has me worried...
...is that LaRouche's plan makes more sense than the take that most of our politicians have on the present crisis. At least he seems to recognize that there's a crisis.
One very real possibility in the comng months to years, is that the conventional politicians will completely lose their grip on the situation because they are so personally wedded to business as usual, or so careful of the opinions of people too wedded to the status quo, that they will prove too slow to acknowledge that its gravity requires measures outside of business as usual.
February 16, 2009 9:44 PM | Reply | Permalink
I continue to be amazed that our "leaders" talk about "toxic" debt. Any bank that has a substantial part of their investments in mortgages has what is now "toxic" debt. It doesn't matter that those mortgages were for 80% of the appraised value of the properties being purchased by citizens with perfect credit ratings. When those fine citizens lose their jobs, and can't make the payments on their mortgages, they will find that they also can't sell the property for enough to pay off their mortgage - not even close. Being such fine upstanding citizens, and smart to boot, they will default and move on with their life. Now the banks will have those properties and be unable to sell them for enough to cover their losses.
I suspect it will very soon be difficult to find a bank that isn't insolvent.
By the way, does anyone want to buy the Brooklyn Bridge? Ok, then how about some toxic debt? I'll take the bridge, thank you.
February 16, 2009 10:31 PM | Reply | Permalink
Had a scary Obama/Lincoln thought today. Has Obama already found his two-headed MacLellan in Summers/
Geithner? If so, I hope he finds his Grant, Sherman, and Porter just as quickly!
February 17, 2009 2:33 AM | Reply | Permalink
This is a very confused post.
For example, assets don't fund liabilities. Bad loans aren't marked down to "realistic market values".
You say receivership should be process which "pays off depositors, wipes out shareholders, and then closes the bank". What about unsecured creditors? For the clearing banks, these are the biggest class of claimants, so let's not forget about them.
Your third category of banks is in practice indistinguishable from the first. How do you tell the difference between a bank with duff assets (i.e. insolvent) and a bank with duff assets (i.e. insolvent) that will recover when the economy improves? No-one's yet invented this crystal ball.
I don't know what Geithner has in mind with his plan. He threw out the term "stress test" as bait to numbskulls, as a talking point for dopes. Does anyone here know what a stress test is? Has anyone stressed a portfolio?
Here's the headline - a stress test tells you what happens in a particular scenario. What you are after is an indication of what happens IF event X occurs. For example, if the S&P 500 loses another 10% of it's value, what happens to your portfolio? If Case-Shiller drops another 20%, what happens to your portfolio? If a major bank goes bust, what happens to your portfolio?
Basically, you conduct stress tests to identify hidden correlations in your portfolio. To establish if you have concentration risk, to figure out what sort of catastrophe hedges might be prudent.
So what is Geither's stress test? Or more to the point, does it in fact matter what the stress test is?
Ironically, given you are pretty clueless on the overall subject of banking crises, you have however stumbled upon the fact there are three categories of banks that the Fed is dealing with.
The first is - solvent and liquid banks. Banks with a positive NAV (because assets are generally performing) and no imminent need to access new funding, or foreseeable difficulty doing so.
The second is - solvent but illiquid banks. Banks which have a positive NAV but with an imminent need and likely difficulties accessing new funding.
The third is - insolvent banks. These banks are bust. They need to be shut down and wound up. No good money after bad.
At this juncture, with all the Fed has already done to flood the banking system with liquidity, it seems pretty hard to imagine there are many Category 2 banks. But let's assume there are some, and if they can make the case that with Fed life support they are still viable businesses, so be it.
But there cannot be many. And given the preponderence of evidence that solvent banks generally survive in times of panic without much government help - http://fraser.stlouisfed.org/docs/meltzer/calcon97.pdf - the Fed should be setting a very high bar for any bank wanting to make the case that they are solvent but still needing a lifeline from the Fed.
I have no idea if this is Geithner's plan, but it would be helpful if people started asking questions along these lines.
February 17, 2009 8:09 AM | Reply | Permalink