Is Everyone Confused Yet? (Bank Stress Tests)

The public relations campaign packaging the bank stress tests is kicking into high gear and our professional information managers are really hitting their stride.  They face, of course, a classic spin problem: you need to get the information out there, but you don’t want to be too definitive on the first day or soon after – if you’re easy on the banks, that looks bad; if you’re tough on the banks, that might be dangerous.

The best way to handle this is by jamming your own signal – which they are starting to do in brilliant fashion.  To the WSJ you leak that BoA needs to raise a great deal of capital ($35bn); they run this story on the front page, next to a great frown on the face of Ken Lewis.  But you tell the FT that Citi will need “to raise less than $10bn” (note that the on-line FT version of this story, as of 8:30am Eastern, seems to have been adjusted downwards relative to the print edition that arrived at my house 4 hours ago.)  The NYT yesterday sounded quite upbeat.

Of course, deliberately or inadvertently confusing people is made much easier by the fact that the experts are in sharp disagreement.  Goldman’s Jan Hatzius says that the worst is now behind us in terms of loss recognition and pre-provision earnings will be much higher in the US than they were in Japan during the 1990s – here he and others are taking on the IMF’s Global Financial Stability Report.  And he has two good points in this regard,

Although we agree that top-line revenue growth is likely to be relatively weak, this should be offset by cheap and largely government guaranteed funding, a steep yield curve, and ample spreads on bread-and-butter lending. We believe that these spreads will remain relatively wide even as risk appetite returns, because they partly reflect the lack of lending capacity following the demise of the shadow banking system and not just the cyclical increase in risk aversion.

In plainer economic terms – the big banks that survived have more market power and access to large government subsidies.  Larry Summers is quite clear: “supporting financial intermediation” is a “critical node” in the President’s economic strategy.

Still, Dick Berner of Morgan Stanley pushes back, arguing that the cumulative losses will continue to increase, “Upward revisions to our loss estimates reflect higher loss severities, primarily in securities.”  And other well-informed parties continue to warn about forthcoming problems in commercial real estate, consumer balance sheets, and of course the European economy – I’ll review the latest European developments in my Economix column tomorrow, but let me preview it this way: not good.

What will be the overall impact of tomorrow’s stress tests announcements on understanding of our overall economic and financial situation?  To paraphrase slightly Larry Summers’ smiling response to a question (actually on the future of Fannie and Freddie) after his recent speech at the Inter-American Development Bank, “if you think that was a clear answer, you weren’t paying close enough attention.”

By Simon Johnson

83 thoughts on “Is Everyone Confused Yet? (Bank Stress Tests)

  1. So does any independent thinker believe these stress tests have accomplished, could have accomplished, were meant to accomplish, anything other than to try to be all things to all people? Anything which is so malleable as to support just the sample of opinions, reportage angles, and “truthiness” exampled in this post is hardly likely to have any underlying rigor.

    Each of these “stress tests” is really an op-ed piece which doesn’t even have a strong point of view, except to put across the idea they were always meant to put across: the banks do need more bailouts, but don’t need to be nationalized.

  2. Russ, more than Op-Eds, I think they have turned into Tweets :)

    It is nothing more than a number and a name that fits well within 140 characters and changes rapidly.

  3. Given the way BAC has reacted this morning – up 8% in first 10 minutes of trading – and how the market has been doing overall, I think the expectations are that another 34B are just a drop in the pond… the worst is over and nothing can stop this bear market rally right now… certainly not sugar-coated stress test results.

  4. What an opportune–and great–time to break up the big banks. The biggest were made MUCH bigger last year (JP Morgan/Bear Stearns/WAMU, BAC/Merrill Lynch and Wells Fargo/Wachovia). Those that have survived, at least this far, are seeing their market share soar because–as Simon points out above–competition from nontraditional lenders has disappeared.
    Yet the Fed is subsidizing the heck out of these monstrosities, hoping that (as Warren Buffett keeps saying) the biggest banks will earn their way back to prosperity–or, at least, solvency. But think what could happen if zombie banks were retructured into smaller, healthier entities? They would become kick-ass lenders all over the country with prudently more aggressive lending backed up by solid financials.
    Finally, it still slays me every time I remember that Citigroup was almost allowed to take Wachovia under its tent. Could you imagine that one today?

  5. Matthew Richardson and Nouriel Roubini send a few showers on the sunny optimists spreading good cheer about the stress tests:

    In their op-ed piece, they estimate the banks’ losses to be in the $3.6 trillion range – which means that the US financial system – even after the extraordinary infusion of TARP capital, is “currently near insolvency.”

    And they suggest that “the government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money.”

    A sentiment I love!

    Larry Summers may think offering up clear answers is a joke – but he may want to rethink that strategy.

  6. the recent spin is inevitable. this blog (and this comment by the way) are part of it — we participants are all part of the comet tail of this big spin.

  7. Simon – although I should say feel this way, it is really incredulous at the amount of politics involved in dealing with the banking and economic crisis. By politics I don’t mean the policy debacle, I mean the BS and spin that goes on with reporting on the bank stress tests. As I’ve previously mentioned in, and as Dick Berner states, once all GAAP accounting has been applied and everything is trued up, losses will absolutely be greater. What did the stress test project really accomplish when all is said and done?

  8. Simon – although I shouldn’t feel this way, it is really incredulous at the amount of politics involved in dealing with the banking and economic crisis. By politics I don’t mean the policy debacle, I mean the BS and spin that goes on with reporting on the bank stress tests. As I’ve previously mentioned in, and as Dick Berner implies, once all GAAP accounting has been applied and everything is trued up, losses will absolutely be greater. What did the stress test project really accomplish when all is said and done?

  9. Pres Obama true heir of Mayor Daley? “We’re not here to create disorder but to preserve disorder”

  10. It seems like we have forgotten all about the toxic assets on the bank’s balance sheets. It is very confusing what exactly is going on here. Is the Fed saying these banks are fine with the additional capital and there is no need to deal with the toxic assets??? Doesn’t that put us directly in a low to no growth environment in terms of bank lending????

  11. Sometimes comedy provides the best clarity. On last night’s Daily Show in an answer to the question, “So does this mean the banks are okay?” The “correspondent” answered “Of course not, the Stress Tests will make the banks look okay, so everyone will put in there money, and then they will be okay.”

    I don’t think it’s been said better.

  12. Speaking of the IMF Global Financial Stability Report, I’m puzzled that the Stress Tests are getting serious attention. That IMF report pretty much said the US finance system was in deep trouble.

    If the IMF is right there are $2.8 trillion in losses in the US financial system, and $1.8 trillion will be needed from taxpayers to deal with that (see 21 April at

    These numbers appear to line up pretty well with the Federal Reserve’s Statistics on the US banking system (see In March the non-international position of US banks was total assets $12 trillion, total liabilities $11 trillion.

    In other words, unless foreign operations of US banks were much more soundly run than those at home, the value of equity in US banks is pretty much zero.

    I’m happy to be corrected on this but that would appear to be why Roubini is so pessimistic.

  13. >The best way to handle this is by jamming your own >signal…deliberately or inadvertently confusing >people

    this is an excellent summation/insight in their technique. We are getting an entire education on propaganda campaigns from how they are “handling” this crisis.

  14. It seems to have become quite clear that the administration’s goal is to let big banks “earn their way out” by providing a favorable yield curve through low interest rates. The insidious thing about this is that it will work only so long as inflation does not return. If inflation returns, and this forces the fed to raise rates (commensurate to what the bond market is charging), the effect is synergistic – and we have the S&L version of this crisis (they are paying higher rates on short borrowing than they are earning on long lending).

    Presumably, if that happens then assets should reflate in value (isn’t that what inflation means?). This would reduce loan defaults by increasing home/commercial land resale values. But the question is how fast bank loan losses are reduced by asset value reflation versus how fast bank earnings are reduced by unfavorable moves in the yield curve.

    Real estate value reflation is a slower-moving phenomenon than bond prices; they are stickier. Bond prices project expected future rates instantaneously into the present. If inflation returns, therefore, it seems likely that we will have a “death valley” in which bank earning power will decline dramatically and asset prices will see a delay in catching up.

    Thus, the Fed needs to reverse asset price declines _before_ inflation peeks through. Or massively recapitalize banks prior to losses (while it still seems that they are massively profitable on an operating basis).

    As I’ve said before, the Fed is trying to thread a needle – I’ve wondered why, but it now seems like the commitment to allow banks to earn their way out is a plausible explanation.

  15. Separately,

    It’s hard to tell whether the leaks are intended to propagate confusion, create low expectations (than can then be easily beaten), or something else.

    Krugman thinks it’s neither expectations management nor deliberate confusion – but rather testing the waters to see what the Street thinks is harsh enough but not too harsh.

  16. Thanks for keeping us informed about the PR side as well as the economic side of our current economic situation. Our benighted press, in pursuit of ‘objectivity’, doesn’t even try to cover the spin, other than repeat it ad nauseum.

  17. Kirk;

    It would be nice to “break up the big banks” and have “kick-ass lenders all over the country”, but exactly how do you propose to get from here to there? What power, what authority, would you start with today that wouldn’t throw your entire effort into the courts? [In my county there is a 16 month-wait to schedule a courtroom in civil cases.]

    The strongest suggestion by far in Bernanke’s presentation yesterday was yet another plea by him for resolution authority. He in no way suggested that the worst was behind us in terms of bank solvency and, in fact, specifically warned that another shock to the banking system would delay what he characterized as a weak recovery. Let’s give it to him (unless you want it to be a congressional authority.)

    I’m sorry, but I think we’re stuck! I think all we can do is re-regulate the financial system looking forward and wait until hard measures of economic health (employment and production) turn up before we undertake major restructuring.

    Our old truck has a flat tire by the side of the road. We have to fix that so we can get it into the shop before we rebuild the engine.

  18. I have a question. If the banks earn massive profits by riding a favorable yield curve, and that yield curve is only favorable because it is being manipulated by the Federal Reserve…

    …then where, exactly, are the profits coming from?

    If I were to argue that “help the banks earn their way out” is another way of saying “fill the multi-trillion-dollar hole in their balance sheets with printed money”, would I be wrong?

  19. Seriously, do they think this is North Korea? Next step, the administration installs a loudspeaker on every corner that drones about how safe the banks are, while in the meantime they print money to pad the banks’ net interest margins?

    I can’t wrap my head around the fact that our government is actually going to tell us that the banks only need a few billion here or there, when they have already proposed trillions of dollars of intervention and programs to relieve the banks of their “legacy” assets. How is this anything other than a major propaganda exercise?

  20. if inflation returns then writeoffs of old loans should be lower, however, no?

    i think a part of the new strategy as well is to provide a stable time for banks so that they can raise new equity capital in private markets.

  21. StatsGuy;

    Excellent post. Sen Brownback made a similar point yesterday, but not as completely. Bernanke mentioned raising rates as one of his tools for sidestepping inflation. Presumably, at this point, he is more concerned about deflation. (One thing that would help is if preferred stock issued under the CPP not be converted to common but to “cumulative preferred” with dividend payment deferred and predicated on a pre-determined level of solvency.)

    The Fed for sure is threading a needle. There is no assurance that we are not on the shoulder of another slide in home values. And now the commercial real estate cycle is beginning to turn down. How low is low? There’s a saying: “The markets can stay chaotic longer than you can stay solvent.” We may just be a decade-long lesson in what this really means.

  22. So I will add my own noise to the spin. Let’s say that the more noise that is added, the harder it is to see the real signal. Let’s suppose that the signal was clear a week ago Friday (4/24) when the banks were first briefed on the results. Let’s further assume that there are no secrets on the street and that by Monday morning (4/27) the “signal” was clear on the results. Have a look at this chart on what happened during trading that Monday, and it becomes clear which banks failed the tests…

  23. That big bank stocks are rising in price on the leaks of stress test reports that they need to raise large, but not–relatively speaking–huge amounts of additional capital is a puzzle.

    More than forcing the banks to do anything drastic, it seems that the stress test results are being used as a rationale for converting TARP advances into common equity, diluting the common.

    I recall that when the stress tests were announced, it was said that they would be used to determine how much capital the government would contribute to needy banks. There was then broad agreement among economists that re-capitalizing the banks was essential to stimulating a recovery.

    Debt, such as the TARP advances, that is converted to equity is debt that never has to be paid back. It might be said that dilution was baked into the TARP advances. Once TARP advances are converted to common equity, the funds can only be recovered by the US Treasury through a sale of its common stock holdings. As a minority stockholder, Treasury will have no special powers or influence.

    The stress tests results are confidence-building in that they signal the low likelihood of nationalization or seizure. Reform at the moment seems a distant prospect.

    I have commented previously here that as taxpayers, we really ought to be watching the acid test of liquid assets to FDIC exposure on a bank by bank and system-wide basis, which would at least tell us where we stand excluding any kind of asset whose value is at all questionable.

    What’s wrong with the ebullience in the equity markets on the leaks of the stress test report is the over-estimation of profit-making opportunities in an economy likely to stabilize at anemic growth rates, high unemployment, low capacity utilization rates and inflation in one form or another. Opportunities for lending will not be great in that context. Companies which have managed to hang on through the contraction may fail from exhaustion or be unable to muster the internal and external resources to recovery. Typically, loan quality in banks deteriorates for a long time after economic measures and the equity markets proclaim the end of a recession.

    The actual release of the stress tests may surprise despite the spin.

  24. I am not confused. It is obvious what to choose:

    a. economic recovery and growth but potential inflationary threat (no inflation yet)

    b. continue deepening economic recession and possible deflation

    This stuff is only confusing if you misplaced your priority.

    I have been busy these few days. Tomorrow perhaps I’ll try to put together something more substantial.

    In the mean time, here is why I think focusing on bank solvency is grossly misguided and my beef with SJ and JK.

  25. not completely.

    if you have money deposited in a bank, presumably the bank is loaning that money out to someone else, and they are presumably making money on this by charging the someone else more interest than they give you on the deposit. do you feel cheated?

  26. One more thing. Banks’ fear of government actions that will threaten their survival will gradually subside as time goes by (e.g. WaMu, Wachovia, and etc). This is the last over hang that prevent the banks from lending more freely. When a bank has to choose between survival vs. making money, the choice is also obvious!

    [audio src="" /]

    Once the threat of survival is lifted from the banks, the current incentive to for the banks to lend is huge! It is good for the economy and good for the banks!

  27. The way Simon tells the story, you would think that the media are the innocent victims of government manipulation.

    I can understand this. I think Simon has a column in the Washington Post or some other journal. You don’t bite the hand that feeds you. So let me do this for him.

    The media are not the victims of government PR, they actively participate in the making of the propaganda. Simon contends that financiers own the government. Of course they do. And of course they also own the media.

    Sometimes a Simon Johnson or a Roubini will voice anti-financial-elite sentiment in some journal. But that will never be on the first page or in a form that everybody can understand. Simon made the second page of The Atlantic. But who reads The Atlantic? What’s their readership?

    When will a really mainstream media say on its first page: “Folks of the middle/poor class, you are being conned right now. You will take the hit for this financial crisis. Obama will do all he can to protect the rich, bank owners and creditors.”

    Let me end with Chomsky’s eternal words:
    “Propaganda is to democracies what the bludgeon is to dictatorships.”

  28. The sad thing is we’ve already seen this decade thing play out – Japan!

    I guess it’s true, he who fails to learn (understand) history is doomed to repeat it.

  29. Nemo – thanks for posting the Onion link. I guess if you can’t get out of the forest because there are too many trees, you might as well laugh, right?

  30. Bill,
    I am not a lawyer or an economist but I do think that political means can be brought to bear to breaking up the big banks. The largest banks are getting a totally free ride currently with the Fed practically giving away money and they are using it to pick the low hanging fruit (e.g., buying treasury securities). This is how they plan to “earn their way” out of their problems.
    But what if the Fed and the Treasury outlined an end game the beginning of which could be initiated at any time by realms of the federal government who could change the “game plan” going forward. In other words, make zombie banks REALLY earn their way out of their messes. Withholding just a FEW of the favors currently being offered to the likes of BAC and C would send them reeling. I wouldn’t be opposed to breaking them up first at great cost to current stockholders and bondholders. It is in the PUBLIC interest to have stronger and better run banks.
    Once either BAC or C is made to see the light, the screws could be tightened on WFC and others. Let them show us how viable they are without so much help from the Fed.
    But we need them to lend, you might ask? Well they aren’t currently, so what’s the difference. On the other hand Simon Johnson, Paul Krugman and fans of theirs like me could be all wrong. Maybe corners are being turned and we’re already close to being out of the woods. That’s what Wall Street seems to pay saying and Ben Brenanke pretty much claimed yesterday. And they’ve never been wrong about the economy or the banks over the past two years, Have they?

  31. I thought the fact that some of these banks are going to come knocking on the government’s door for a lot more taxpayer money constitutes the leverage needed to undertake a restructuring or breaking up of the banks, such as an RTC type of situation. Isn’t that what Simon Johnson and the others in that camp have been saying, in a nutshell?

  32. Poignant commentary johnGalt. It seem obvious that “…the commitment to allow banks to earn their way out is a plausible explanation” of the Obama economic teams actions. And johnGalt also seeringly points out that the “commitment” is acquired or abrogated more accurately by pillaging the American taxpayer, shielding the oligarchs and predatorclass cronies who own and profit wantonly from the oligarchs, and heaping the monsterous debts and deficits on the shoulders of our children.

    It is also shatteringly obvious that “Obama will do all he can to protect the rich, bank owners and creditors” to the great disadvantage of, and deleterious future impact on America’s poor and middle class.

    As I have stated before, – ours is a government of the predatorclass, by the predatorclass, and for the predatorclass.

    Unspoken in all of this lofty banter, is what other alternatives could have been, or may still be applied to resolve this crisis in a more structural, economically sound, fiscally responsible, and equitable manner, that did not heap all the monsterous costs, debts, and deficits, and force all the burdens, hazards, pain, and suffering on Americas poor and middle class exclusively.

    If by some miracle, the ominous commercial real estate, pension fund, treasury bill threats looming on the near horizon, or some non-economic natural or unnatural disaster are avoided or escaped and the banks are theoretically able earn their way out of the worst economic calamity since the great depression, – it may be good news for the oligarchs and the predatorclass cronies profiting from the oligarchs, – but poor and middle class Americans are in for a long hard slog, and entirely new paradigm of what is the American dream.

    I dare not imagine what will happen to America’s poor and middle class if there is another shock to the system that disrupts the Obama team’s “needle threading” strategy. I’m long on pitch-forks, Colt, and Smith & Wesson

  33. On the one hand, we have Roubini and IMF studying the banking issues indirectly. On the other hand, we have hundreds of seasoned bank regulators going over the books with the banks directly.

    Who to believe? If nothing else, the government should have better data even if you believe hundreds of regulators choose to lie together. At least they will be lying with their eyes wide open!

    There are some talks about Geithner only looking after the banks’ interest. On the other hand, Roubini makes a living by providing economic and financial advice. Furthermore, IMF’s funding depends on contributions from various countries. The worse the crisis, the more money IMF gets and the bigger the role it will play.

    At least so far, no one has been able to identify any direct conflict of interest with Geithner. He has been a public servant his entire career.

  34. Subsidized borrowing rates. Subsidies are provided by inflation (which is fine for now since it counter deflation, providing the country a beneficial service).

    But can this be sustained when/if the environment turns moderately inflationary (which, hopefully, it will)? What about if we see significant inflation (which, hopefully, we don’t)?

  35. In an attempt to sort out the spin…

    Simon Johnson, ex IMF, is with the a good friend of the Sloan Foundation, MIT, and the Peterson Institute. Peter Boone is with LSE and an interesting charitable organization. James Kwak was with a company that runs a back office platform for the insurance industry and is now a law student. It “looks” as if Baseline Scenario was launched by professioanal PR people to the top of the econ blog heap fairly quickly. They had a trajectory similar to Roubinis. Coincidentally, the Peterson Institute now runs their blog at Roubinis RGE Monitor. So it “looks” like there’s a little overlap here. The really curious thing is that we see some criticism of Summers here, but before he slid into his present advisory position he was an advisor at RGE Monitor. What was he doing there? Collecting a paycheck, like at D.E. Shaw? Or just there to enhance their cred? In any case, bringing this down to the schoolyard level — Summers and Roubinis operation are friends. Peterson and the Roubini are friends. It doesn’t seem likely then that earnest jabs at Summers would be made from this blog. Was the purpose of today’s post twofold: 1) To generate a “limited hangout” by talking about how others are flacking, thus deflecting the spin that is Baseline? 2) To create a perceived distance between Baseline and Summers?

    I may be way off base here, but there is most assuredly a war of perceptions going on and we should define Baseline’s place in it, or establish their perfect impartiality.

  36. Honestly? Yeah, I kind of do. Anyone who makes money merely because they already have money is a pure leech on society, in my view.

    But putting that aside… I think the issue is what sorts of loans the bank is making. If they are providing financing for some small business, placing their money at actual risk to help some exciting new company get off the ground, that is one thing.

    If they are merely riding the yield curve from short-term to long-term Treasuries, that is something else.

    If they are re-starting their marketing efforts to convince municipal governments to invest in Synthetic CDOs or whatever, then that is something else yet again.

    I am convinced the Fed can make the banks highly profitable. In nominal terms, anyway. But I am not at all convinced that this is either necessary or sufficient to repair the system.

    Time will tell.

  37. Yes, silly things – and the regulators are saying that a bank that just declared a profitable quarter – the illustrious BoA, which has previously received $45 billion from TARP – now needs more than $30 billion of new capital to prop up its operations.

    However you slice it, the fact is – the financial sector is a mess. Painting a rosy glow on a mess does not change the fact you’ve got a mess on your hands.

    The worse this crisis gets, the more (public) money gets siphoned to the private sector known as Wall Street, that proud bastion of capitalism.

    As a proponent of capitalism myself, I continue to support Roubini and Matthewson’s statement that “the government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money.”

    Find fault with that?

  38. Printing money and giving it to the needy — or merely the productive — might be a “beneficial service”.

    Printing it and handing it to banks sounds to me more like theft.

  39. I think that’s exactly right, in fewer words than it usually takes me. Each stress test is a piece of marketing.

  40. Along your line of thinking, I believe Sheila Bair as head of the FDIC deserves more attention (and support from citizens) than she is getting.

  41. Is there any evidence at all that there is any recognition in our policy response so far that the system was actually broken going into this crisis? So far as I can tell, the goal is to calm the waters enough so that when it is “done” business can be conducted in exactly the same manner it was a year ago, i.e. the same system AND the same people that created this crash. Am I missing anything? Fool me once, shame on me… fool me twice, watch us crash and burn in flames?

  42. Technically, banks are supposed to make money by:

    Providing bricks-and-mortar financial services (e.g. retail banking products)

    Absorbing intertemporal risk (against their capital cushion). They are paid a nice fat fee for absorbing such risk (unless something “wrong” is going on, which is generally signalled by an inverted yield curve) – otherwise, short term rates would exactly equal long term rates.

    Leverage allows banks to magnify the impact of the delta between short/long term yields. If that delta were to stand at ~4-5 percent (due to cheap borrowing from the Fed), and they had a leverage multiplier of 12, then that’s some pretty hefty profits.

    What services are they providing for these profits?

    Why, they’re absorbing risk by offering up their large capital cushions as collateral. Isn’t that obvious?

    OK, yes, I’m being sarcastic. Yes, it’s a one way bet, and yes they are not even betting with their own money at this point (whatever is left of it).

  43. It is very important not to over look the the importance of public confidence during a financial crisis (any crisis). We may feel the superficiality objectionable. However, during a crisis it often can play a key role to change the course of the outcome.

    You may want to dig up other academic analysis on this.

  44. Manchester United was the star of the European sports media last night, winning a big game in London against Arsenal. Wearing AIG’s corporate logo in front of millions of viewers, Ronaldo scored 2 goals. Did any AIG execs fly in for the game?

  45. ‘the current incentive for the banks to lend is huge, its good for the economy’
    What incentive is there to borrow? Most people have all the “stuff” they need and a pile of debt they don’t need. When will you debt mongers say enough is enough? When total debt is 1000% GDP?
    Face reality, we can’t move forward by creating more and more unservicable debt. So, unless you have some ideas that are based on reality, ……..

  46. Anne,

    One more thing:

    “The worse this crisis gets, the more (public) money gets siphoned to the private sector known as Wall Street, that proud bastion of capitalism.”

    This is why I think we need to be focusing on turning around the recession instead of worrying about bank solvency. Simon Johnson has admitted that cleaning up our banks is “not necessary (or actually sufficient) for a rapid economic recovery”.

    The last 2 are debates on the subjects of cleaning up our banks and implication for recovery from the the Peterson Inst. They are excellent.

  47. I agree American consumers should save more.

    On the other hand, credit is also the life blood of American entrepreneurs and innovators.

    Case in point, I am positive the technology that you just used to composed that last message can be traced back to some entrepreneur to finance its development.

    Is that reality enough?

  48. Get ready, the sharps have hoodwinked the masses to get into the bank stocks, watch out below. The dumping to commence soon…

  49. statsguy, i’m confused about something here, maybe you can answer. my impression is that short term rates are low mainly because of a strong investor preference for short term instruments. long term rates are set in the market, but the fed is buying long term treasuries, which should make long term rates lower. (the fed is also buying mortgage backed bonds in order to keep mortgage rates low). thus federal intervention actually lowers the long term / short term spread, which lowers bank profitability. what am i missing here?

    if it’s really working this way, then the federal government and home buyers actually get the first cut at the money, not the banks.

    here’s my reference:

  50. After Simon pointed to the vulnerabilities of the banking systems in Europe, I decided to check. The findings support his conclusions. Ying Lin and I analyzed the condition of the various banking system in the world, and get a sense for the capital shortfalls. We estimate that the largest banking systems in the Europe have $2,438bn in Tier 1 capital and a capital shortfall of $3,397bn; In East Asia, the largest banking systems have $1,189bn in Tier 1 capital and a shortfall of $758bn. The findings of this article are twofold. First, there is a global shortage of bank capital. Second, the largest share of bad assets belongs to European banks, and Europe has both the biggest capital shortfall and has made the least progress in restoring the banking system to health. The capital shortage is global
    May 1, 2009 7:10pm by FT
    By Michael Pomerleano and Ying Lin

    Posted at

  51. Wow, it’s amazing what needing $34B can do to one’s stock price. But I gotta hand it to the banks…it looks like they’ve made it out of the wilderness and to the end of the rainbow. I guess the only thing left for them to do now is collect their pot of gold…and kudos to the adminstration for its leadership…only thing left for them to do is hang up their “Mission Accomplished” sign. In Goldman we trust.

  52. David: “What incentive is there to borrow? Most people have all the “stuff” they need and a pile of debt they don’t need.”

    They would happily borrow at low rates to pay off the pile of debt at high rates (that they accumulated on their credit cards). If there is a low demand for credit, why are the credit card companies raising rates? (Rhetorical question. ;))

  53. This is more like a sci-fi movie; once the truck gets its tires fixed, it isn’t going to pull over and let you rebuild its engine. The only shot we have of rebuilding the engine is when it is immobilized.

    The Administration has never WANTED to fix the engine.

  54. That’s what happens when you let the banks negotiate the tests.

    If the FDIC bank seizure plan involves seizing the firm in complete secrecy on Friday night, and if secrecy is of sufficient value that it fired on WaMu a day early to cope with rumors, you would have hoped that the group appreciated the importance of not talking to the affected banks.

    Unfortunately, this is what happens when you have the political team driving the technical team. Rahm wants message testing (as though this were a direct mail campaign) and that means persistent leaks and trial balloons.

  55. q,

    I wonder about that.

    Hearing the concerns of men like Simon Johnson, Bill Black, Nouriel Roubini, etc., I became actively involved in some of the bailout protests – actually, quite a few of them, both on the left and the right, which was a novel experience for me, given that my type doesn’t normally march in the street. I did this at no small cost to myself – I work in the F.I.R.E. sector.

    I’m disappointed that Simon Johnson, while basking in the media’s limelight, has failed to really embrace/support any of the grassroots movements that are involved in questioning the bailout. Look, having worked with several of them, I can understand his trepidation, but there’s a larger failure going on here:

    None of the policy experts/economists/lawyers who have been so critical of TARP/PPIP/stress tests seem at all interested in working together to implement their “Plan B.” You know, a UNIFIED set of initiatives, given power and momentum by a UNIFIED group of dissenting economists. Which we the people (unshiny as we may be) can help them to implement, by rallying bipartisan public support for “Plan B.”

    Do they know something we don’t? (Well, the average flea on a tick on a dog knows more than I do, but that’s another matter.) What I mean is, if this is such a crisis, why aren’t they providing necessary leadership?

    Those of us on the ground can provide an enormous amount of muscle – we can organize, we can educate along the Simon Johnson points, we can raise money, we can mobilize voters, etc. – but without actual leadership from the experts, we’re fighting a losing battle. A losing battle that men like Simon Johnson told us we couldn’t afford to lose. So why the lack of leadership from the dissenting economists?

    Dr. Johnson, may I introduce you to Brooksley Born? I think it could be the beginning of a wonderful leadership duo.

  56. Well put. As you say it looks like the banks have done it again. Somehow nobody within the upper echelons of the banking hierarchy ever seems to pay any price for the effects they cause.

  57. The administration has no idea of how to manage financial markets. Spin, marketing and negotiation may all be fine and par for the course — but the markets thrive on predictability and the appearance of good information and rational, actionable policy. So, far we have none of that. Worse, we don’t even know who is in charge. Impossible to have financial stability in this environment. If you are going to spin it, spin it toward something that at least appears to be fair and rational.

  58. No conflict of interest? You have to be kidding! Please read up on the triumvirate of Rubin, Summers and Geithner and their unholy alliance with Goldman Sachs. Goldman has been calling the shots for the past few administrations.

  59. Long term inflation expectations. Fed QE is perceived as a signal of inflationary pressure down the road (whether or not that materializes is a big debate). The amount of debt the Fed is buying is not actually large enough to materially meet the federal governments needs, however. In fact, the 600 billion is less than the stimulus bill alone, let alone the normal operating deficit of the federal govt.

    So there are two effects of QE on t-bill rates: direct effect (increasing demand, bidding up t-bill prices, and lowering t-bill rates), and indirect effect (by altering inflation expectations). The second appears to be dominating.

    Also, note that the non-t-bill long term rates (the stuff the Fed is not directly buying or supporting through its various programs) are also impacted by both effects.

    If QE were to decrease the yield on govt. bonds, this would presumably push some money out of govt. bonds into other long term bonds, thus dropping rates. (a substitution effect) But again, the inflation expectation effect appears to be slowly dominating.

    (Also, there is a huge demand for refinancing into long term mortgages right now – I suspect that the govt. is deliberately holding rates low for a period of time to shift people into long term mortgages from ARMs and flex-rate mortgages. Obama has directly signalled as much: )

  60. ok, i get it now, and looking at long term swap rates and today’s treasury sale i can see what you are saying. inflation expectations are in — check. if inflation is realized we will have a poor environment for banks as the yield curve flattens.

    however, if inflation takes hold presumably asset prices will have recovered and probably the economy will have recovered as well as people will be encouraged to chase yield. this means that the banks will be facing credit losses that are lower in future real terms. the high estimates that i have seen (estimates of the “banks need $1 trillion in new capital over the next three years”) all assume credit losses on the level of the great depression. these estimates have, i am sure, an assumption of deflation baked into them.

    the push to refinance mortgages should also reduce losses due to default.

    as a side note, also note that the fed stress tests only go out to the end of 2010 and most of the “$1 trillion” style estimates go out until mid 2012 or so.

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