The Fed announced some details of their stress test methodology (this article in the NYT is interesting, too). Unfortunately, there wasn’t really anything new in the announcement. Some people criticized the Fed for this. They wanted to know some details, like “What is the minimum capital ratios you used?” The Fed, of course, didn’t release this information because enough data is publicly available about the banks (and more, privately, for sale) that a decent analyst could have performed the analysis and announced the results ahead of time. Still, there are a few things worth noting:
The focus of the “grades” is on common equity. This is a big motivator for the government to swap preferred shares for common stock. With a wave of a magic wand, the grades can be improved. The banks won’t actually have more money, but they will have better balance sheets, according to a questionable metric.
The “More than 150 examiners, supervisors and economists from the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation participated in this supervisory process” is a joke. Instead of reassuring me that the investigation was thorough, I’m reminded that 160 regulators were required to go over Citi’s US commercial real estate portfolio in 1990. Fewer regulators covering more banks with more complex and hard to value assets in much less time? Shenanigans!
The NYT article throws out the 3% tangible common equity (TCE) number. That (divide … carry the three …) comes out to 33 times leverage. I sincerely hope that’s not how we still describe a healthy bank in the US. Fortunately, that number is not official yet.
The “More Adverse Alternatives” is not particularly pessimistic. This scenario now looks like a highly likely path for the US economy. If banks have 3% TCE for a non-pessimistic scenario, what happens if things are worse than we assume? Again, I really hope that 3% is not the official number.
But the last thing I want to share is a bit of trivia that is often overlooked. Many news outlets are saying “the government doesn’t usually release bank evaluations.” The reason for this is simple: it’s against the law. Yeah, there’s a law against transparency. This protects the FDIC and prevents people from depositing their money in the safest banks — no, really (these things are related). This stress test is not the same as an official bank evaluation. This is intended as theater to reassure everyone that the problem with the banks is being looked at. The people in charge know what is going on. KEEP CALM AND CARRY ON.
