How the banks' stress tests will work
The Treasury Department will submit the nation's largest banks to stress tests before they receive more aid as part of its rescue program. But how exactly will these tests work? John Dimsdale explains.
People walk past a Bank of America branch in New York (Emmanuel Dunand/AFP/Getty Images)
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BOB MOON: Remember when the bank examiner came calling in "It's A Wonderful Life?" Multiply that many times over and you'll get a picture of the intense examination the nation's top 20 banking powerhouses are about to face under the guise of something called a bank "stress test." And until the results are clearly established, bank regulators can't really know for sure what kind of medicine is actually going to be needed. Notice, they signaled today that they have no plans to nationalize banks.
As our Washington Bureau Chief John Dimsdale reports, this close look at the books is the first step in the next phase of the government's bank rescue plan.
JOHN DIMSDALE: Just like a doctor making your heart race to find the flaws, a financial stress test subjects banks to increasingly dire economic scenarios to discover where the flow of money breaks down.
John Douglas runs the banking practice at the law firm Paul Hastings. He says the regulators will apply hypothetical external shocks to the banks' assets and liabilities.
JOHN DOUGLAS: What happens at various levels of unemployment or various levels of house price declines? What does that do to the financial situation of the banks?
Running the banks' operations through their paces also helps regulators identify hidden liabilities like off-shore accounts or over-valued assets, says Jane D'Arista with the Financial Markets Center.
Jane D'Arista: We don't know a lot, and we need to know a lot more. How much is off-balance-sheet now, relative to the capital that these banks have? And what is on-balance-sheet? Can we get a market to price?
That way, regulators can subtract liabilities from assets to see what the banks are worth. And that gives the government a sense of which banks to support, according to the Milken Institute's James Barth.
James Barth: Do they seize the institution, put the institution in conservatorship, or liquidate the institution? Or does the Treasury Department say, 'We're going to inject capital into this institution or not?'
And potential private investors in banks will also scrutinize the test results, says John Douglas.
DOUGLAS: The more knowledge that the private sector has about the true condition of a bank, the more likely the private sector is to invest. Our banking system will only recover once private capital starts coming back into these institutions in a serious way.
And government regulators say that's just what they're aiming for.
In Washington, I'm John Dimsdale for Marketplace.
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From Dallas, TX, 02/26/2009
1. Nationalize the Banks. NO NEED TO DO THIS.
2. Bad Bank, print Trillions to buy toxic assets at the prices set my Chase, etc. This ignites inflation, bad idea!
3. Four Banks today: Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo, and some others as well.
4. Create separate bad banks for each of these four institutions, and finance them by having the government assume an amount of each good bank’s corporate debt equal to the value of the troubled assets put into the bad banks.
5. Each CEO will be given one chance to sell any assets to a new bad bank owned entirely by the government. Assets will be conveyed at year-end, audited book values, not at some inflated price.
6. Right now, those assets are illiquid and depressed, but the government can hold onto these assets until they regain value, with complete transparency.
7. Government pays for these assets by not printing new cash, but by taking an equal dollar amount of each bank’s liabilities, notes, bonds and other obligations. Government, not the banks, chooses which liabilities it would take responsibility for, notes and bonds with maturities of 3 to 10 years. Government pays down these liabilities thorough the cash flow that will be generated from the troubled assets themselves
8. Government hires professional money managers to oversee the liquidation. (Note of Disclosure, this is what my firm does best, getting the most money I can from the folks I work for, in this case, You, and the American People, Mr. President.)
9. The Banks retain strong assets bases, no longer have toxic securities, and will start to extend credit again.
10. Insurance companies benefit exchange weak debt to securities guaranteed by the Treasury.
11. The program must be mandatory. Government should also get stock warrants, the ability to purchase stock in the future at a guaranteed price.
12. These banks become the four best capitalized and cleanest banks in the world. Government could sell the warrants to private parties, another bonus for taxpayers. Private investors exercise the warrants, infusing even more common equity capital into the banks.
13. The Four Banks will have a clean balance sheet and the best capital ratios in the world, and start making new loans.
14. ALL NEW MORTAGE LOANS WILL BE MADE AT NO HIGHER THAN 8% INTEREST, AND WILL BE MADE 15 OR 30 YEAR FIXED, WITH THE FIRST PAYMENT DIVIDED EQUALLY BETWEEN PRINCIPAL AND INTEREST.
15. After the Recovery, Mr. President, you will have the political capital to convert Federal Reserve Notes to a New United States Currency, backed 33% in silver and gold, in exactly the following manner
The U.S. Treasury WILL ARRANGE FOR
1. Loans in freshly created U.S. Paper Currency to Banks to bring their cash reserves up to 100%. All currency labeled United States Notes will be recalled and burned.
2. Banks would pay 3% interest to the Treasury on these loans.
3. Fed borrows from the Treasury the new currency to bring their cash reserves up to 100% to cover their demand deposits plus all government funds against which checks are being drawn by the government. The amount of U.S. Securities held by the Federal Reserve would be credited against these borrowings, canceling an equal amount.
4. 15% flat tax ACROSS THE BOARD, CORPORATE AND INDIVIDUAL.
Richard Peter
Founder and President
The Glorious National Party
Please join us by entering this "witty invention" until our Master Site is completed.
From IL, 02/23/2009
Where are the regulations?
If lack of regulation and oversight led to the current problems, when is Congress going to reinstate the regulations? Before he left for Christmas break, Barnie Frank said that they were going implement regulations as soon as they got back. Well, it's been two months since Congress got back and I haven't seen any news on bank regulations -- just throwing more money at the problem, with no strings attached. What's going to keep these problems from reoccuring? Maybe, that's why the public is skeptical that the bailout is going to work.
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