Banks Stress Tests Will Show Failing Grade

The Crux of the Banking Problem

As the major commercial and investment banks and Hedge funds that participated with them were the beneficiaries of cash that fueled the twin housing and equity market bubbles that just popped last year.  There is a big mess to clean up.

The profits of these behemoth institutions grew on unbelievable volumes of transactions founded on a small base of actual physical assets, that were packaged sold, securitized and resold and banks and hedge funds took their transactions fees repeatedly reaping ever-larger profits, the balloon grew and grew.

The  CEO’s of these “too big to fail” companies were making mega-buck bonuses but what these oligarchs were able to accomplish through their lobbyists in concert with a majority of nonchalant congressmen was to dismantle years of policies put in place to protect America and by their repeal would unleash the Great Depression of 2009 upon America and the world.

Almost unnoticeable deregulation occurred over ten years to help fuel and turbo charger this financial disaster.  The fault lies with Capitol Hill for its quest to remain in power and the financial industries greed that requested and obtained the repeal of those regulations. There are several regulatory changes of note: the Insistence on free movement of capitol across borders; repeal of Depression-era regulations separating commercial and investment banking; major increases in the amount of leverage allowed to investment banks; no Securities and Exchange Commission’s enforcement; an international agreement to allow banks to measure their own riskiness; an intentional failure to consider a review of regulations so as to keep up with the tremendous pace of financial innovation.

The interrelationship between the financial institutions and government is alarming as one cannot survive without the other yet the political balance of power to get the economy headed toward recovery requires letting the free markets work.  Big banks are now in control of trillions of taxpayer dollars, and government can tell them to lend but government cannot make them lend.  Banks will not lend until they see some sign of recovery and that is choking off any sign of economic stimulus to the economy.  Coupled with that are the large losses banks have taken on their securities and loan portfolios, and the government does not want to publicly expose the degree insolvency.

April 19,Bloomberg reports, “the U.S. Treasury and financial regulators are clashing with each other over how to disclose results from the stress tests of 19 U.S. banks, with some officials concerned at potential damage to weaker institutions.  The 19 firms include Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Goldman Sachs Group Inc., GMAC LLC and MetLife Inc. and other commercial, trust and regional banks. The Federal Reserve, OCC, Federal Deposit Insurance Corp. and Office of Thrift Supervision are using the tests to determine whether the 19 have enough capital to cover losses over the next two years should the economic downturn worsen.”

The Bloomberg report goes on to indicate that the economy has worsened since the Treasury announced the stress test in February, as unemployment has worsened and is projected to rise beyond the 7.6% used in the stress analysis.  As some banks have recently shown first quarter profits, the Treasury is concerned that when the report is released April 24th it will demonstrate that these banks will need an infusion of more cash which will erode confidence further.

To break the cycle of the interdependence of government and banks there needs to be a direct relationship of checks and balances.  This government report will identify the banks that cannot survive.  These banks should either raise private capitol or be taken over by the government as the Resolution Trust Corporation did in the 80′s with S&L’s , cut up the assets salvage what can be and sell off the assets to solvent institutions.  The bailouts and looting of the taxpayer must stop.

The big question is does Treasury Secretary Geithner and President Obama have the guts to do the right thing? Congress wants to cap executive pay while Obama wants to create FDR style stimulus when the economic patient is hemorrhaging.  Can the politicians that  fed on the trough of bank dollars and repealed the regulations that kept Americans safe reestablish those regulations, stop the political posturing and break up the too big to fail financial behemoths and restore the foundation of the banking system.  This is a big task for politicians and bureaucrats that allowed this fiasco to happen in the first place.

When the Treasury Secretary’s “stress test” report comes out showing that bank balance sheets are in bad shape it will cause further erosion of confidence in the performance of these institutions.  A fragile US economy, the hope of the world due to its buying power and worldwide confidence in its ability to withstand further deterioration, may cause the economic spiral to accelerate globally.  As government insolvency begins to spread across Europe, creditor nations take further hits, Asian, Latin American, and African economies dependent on the purchases of the west will give up hope of a change.

Without the confidence in the solvency of the west there will be nothing to stop the spiral toward world depression.  If that happens who will pay the debt congress and the Obama administration are saddling future generations of Americas with?