Stressing over the stress test

It seems like the stress tests wasn’t only designed for banks.  Bloomberg reports that regulators are now clashing over the information that will be disclosed on May 4th when the results of the stress tests are scheduled to be released to the public.  It might even prove to be a bigger test for Geithner and company more than it is for the banks.  After all, the word is, all 19 banks will be passing.  That doesn’t seem to be the case for the group conducting the test and disclosing the results.

With a May 4 deadline approaching, there is no set plan for how much information to release, how to categorize the results or who should make the announcements, people familiar with the matter said.

The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers.

While weaker banks deemed to need additional capital will be given six months to raise it, financial markets may have little more than six minutes of patience before punishing them if the information is publicly released, one official said.

Geithner has said he crafted the stress test program in an effort to provide more transparency about the health of banks’ balance sheets.

The scenarios used in the tests are already under fire.  What they assumed would be the baseline/adverse scenario even for 2010 are already on the brink of happening in this early Q2 of 2009.  That’s problem numero uno.  Whatever the results may be, their credibility is already put into question because what might have been supposedly applicable for the next two years, until the end of 2010, would already find itself useful only until the end of this quarter.

The second problem is, despite the (meaningless) results, investors are still expected to react negatively.  Saying all passed would be met with ridicule; saying so and so failed would be a threat to the banks of concern. Either way, it seems to be a lose-lose situation and this might simply be the biggest (concrete) failure yet of the triumvirate.  The scarier thought? May 4 might just be the day when the bear market rally ends.  Stepping back a bit, deciding on the manner by which the results will be released would yet again put Geithner on the spotlight.  Set aside PPIP, the stress test that was well-intentioned is for now Timmy’s biggest test.

So now we share the same question, how do we go navigate through this lose-lose situation?

Aiming for a more general disclosure, say that most banks passed while a few might need more capital would see investors clamoring that the names of those banks be disclosed.  Saying all passed could just erode confidence and turn this whole government effort into a laughing stock.  Revealing the names of only the banks who are safe would automatically lead others to speculate that those not named are not safe. Going for both the general and the specific (that is, the general would serve to be the ‘reassuring’ statement) would not really set aside the truths behind the specifics.

What, then, are the options?

1. Say that all passed BUT push for another test, which would this time use realistic baseline and adverse scenarios that will hold until 2010.  That would probably be a waste of time but what that would do is make the results a tad more truthful and make the regulators admit that the assumptions they used were in fact inappropriate.

2. Expose the names of the banks in danger and let them fail. But some of these would probably be the banks too big to fail and we already know, no one else is failing, or so they say.

3. Declare the names of those who are in danger. Certainly the markets would react negatively, so they must have some plan as to what would be done with the endangered financial institutions. If no banks are failing then, these are the other options: advocate for the dismantling of the giants and separate their bad businesses, put them into receivership or the N word. Yet pushing for one of these the same time that the results come in would be disastrous for the market.

4. Declare the names and just see what happens.  A few points: First, there is an automatic assumption that markets wouldn’t like whatever they’ll hear.  If that’s the case, then there’s not much that can be done, is there? Second, assuming it is true that no one is failing, providing the names of the ones in danger (read: not failing) could drag the market down but with the rally that’s been going on, it might just be time for them to reflect their true values.  While the stocks have been beaten so much, the jump they saw the past few weeks happened too fast.  At one point, they would just have to give that up and start again from the bottom, only this time their growth would be gradual.  Third, it then signals to the Timmy that it’s time to move on.  The test has not been as successful as his group wanted it to be; now move to the next strategy.

Trying to instill confidence to the market when there’s no reason to only prolongs the suffering.  One important fact of this whole stress test seems to be overlooked: the toxic assets still exist.  No matter what the government says or does, for as long as the assets are there, the banks will not get better.  Even if more capital is pumped, those assets don’t go away.  I used to disagree that GM and the banks are comparable, but now I’m having a change of heart.  Putting more money into the banks without getting rid of the toxic assets is like giving more money to GM without seeking concessions from the UAW.  At some point, the banks would have to accept some form of defeat.  I am not advocating that they be allowed to fail nor am I advocating that they be nationalized. They, along with Timmy, just need to go back to the main problem.

With a lose-lose situation, just letting banks be could add another lose situation but maybe it eventually has to happen.  Any form of relief or confidence that comes back, without any significant change in the fundamentals of the market would prove to be short-lived, not to mention it would probably only waste more resources that could have better use.  By aiming for number four, I am not sure what else could happen.  The only thing I’m almost certain about is that no matter what the outcome, this stress test could be the catalyst for the retesting of the lows that everyone has been talking about.

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