Page 1 of 2 Oh, impotent Washington
By Julian Delasantellis
In the long, colorful and storied history of the sweet science known as
professional boxing, few nights are as memorable as November 25, 1980, in New
Orleans' Louisiana Superdome, which staged the first rematch between pugilists
"Sugar" Ray Leonard of the United States and Roberto Duran of Panama.
During the previous summer, Duran had prevailed in the pair's first contest in
Montreal, so the pre-fight expectation would be that at least Leonard, and
possibly Duran, would be fighting hard for pride. But late in the eighth round,
Duran drooped his gloves, indicated that he was giving it up. He said something
to referee Octavio Meyran, who immediately stopped the fight and awarded it to
Leonard.
There is no small measure of controversy over what it was that
Duran actually said. His trainer claimed that the Panamanian said upon quitting
the Spanish equivalent of "I won't fight anymore with this clown." However, it
was the late sports commentator Howard Cosell's version of the end of the fight
that has been accepted by popular culture as to what actually happened. Cosell
says that Duran quit uttering the words "no mas, no mas", Spanish for
"no more, no more."
Following this, the phrase "no mas" entered the English pop culture
lexicon as a hip, current way to say "I quit" or "I'm through."
Now, with the release of the US Treasury's "stress tests" of major US financial
institutions, it seems that it is Treasury Secretary Timothy Geithner who has
dropped his gloves and left the ring, affirming "no mas" to any more attempts
to save the banks through some sort of active disposition of the toxic
mortgage-backed securities and derivatives on their portfolios.
A few years ago, the medical establishment started to notice a problem
concerning the standard yearly checkups being given to patients, especially
middle- and late middle-aged American male patients. That problem was that just
because you were walking out of the doctor's office with a purported clean bill
of health did not mean you weren't going to die of cardiac arrest before you
got home. This was an especially critical problem since these patients died
before they had a chance to pay the bill for their office visits.
The doctor may have heard nothing anomalous from listening to your heart
through his stethoscope while you sat quietly on his examination table, but
that said little about whether the heart could withstand the higher levels of
stress it would suffer under intense physical exertion or emotional stress. So
was born the cardiac "stress test"; in essence, this is an analysis of the
heart's function conducted while the patient was walking on an increasingly
arduous treadmill, or, while the patient was being injected with drugs that
artificially stressed the heart. In this manner, lots of people who passed
sedentary heart tests were determined to have significant underlying coronary
artery disease, and appropriate interventions could be initiated.
When you rise up to the highest levels of American finance, for instance if
you've previously been the head of the New York Federal Reserve prior to your
current position as the newly appointed US Treasury secretary, you probably run
into a lot of people - probably including yourself - under a lot of stress.
That stress probably leads their doctors to prescribe a lot of stress tests.
Thus, when, in mid-February, when Timothy Geithner announced that the Treasury
would be prescribing "stress tests" to major financial institutions operating
within the US, I always thought that he was just using and adapting a phrase he
had heard so many times previously in his Olympian peer group of people who run
the world economy.
At first, the stress test proposal, called the Supervisory Capital Assessment
Program (SCAP) didn't get that much attention, since it was released along with
the wailing debacle that was the first draft of Geithner's Public Private
Investment Partnership scheme to deal with the banks' toxic mortgage
securities. However, the idea gradually began to take shape.
Government auditors would do a thorough examination of the banks' books,
testing their loan portfolios and capital adequacy against various scenarios,
such as a sharp rise in unemployment or another significant leg down in house
prices, that would "stress" bank reserves even more than they are being
stressed already. If it was found that the banks' capital would not be
sufficient to withstand the demands of the more negative scenarios, the
government would mandate the banks to take on increased capital - just how they
were supposed to get this capital was a very open question.
A friend asked me to accompany him to his cardiac stress testing because his
doctor said he might need help getting home. When I got there I saw why the
doctor made the request; all I can say about cardiac stress testing is that
it's a lot like waterboarding, except for the fact that at Guantanamo they
never asked the detainees for their health insurance card before commencing.
The treadmill is inclined and accelerated to levels of intensity that would get
you thrown out of your health club; I guess if you can go through that and not
go into cardiac arrest you're allright.
There are many questions as to whether the bank stress tests are that
demanding. The banks were tested using the economic metrics of forward
projections for US gross domestic product (GDP) growth and unemployment, with
two scenarios, an optimistic "baseline" scenario and a more pessimistic "more
adverse" scenario. In both cases, there are serious questions as to whether the
most pessimistic scenarios are too optimistic.
In one, GDP is predicted to bottom out at a minus 4% level in the second
quarter of 2009, even though GDP contracted at rates over 6% in the last
quarter of 2008 and first quarter of 2009. The worst case unemployment rate
scenario is predicted to be about 9% in the second quarter of 2009; that's
essentially where the actual rate is now. If employment continues to shrink at
anywhere near its current rate, even if there is the return to nominal economic
growth that the baseline scenario predicts by the end of this year, the
unemployment rate will soon exceed the most adverse scenario's predictions of
being over 10% by the middle of next year.
The problems inherent to this mendacity are obvious. If economic assumptions
turn out to be overly rosy, than the assumptions on banks' economic health,
especially the health of their mortgage, commercial real estate and credit-card
loan portfolios, should be suspect as well.
Still, when the markets realized that the stress tests may have had
questionable underlying assumptions that put their value into question, they
had a fairly curious reaction. They hooped and hollered for joy. Financial
stocks have been a key component of the 35%-plus rally in the S&P 500 share
index since early March, with the stock of Wells Fargo up 236%, Bank of America
up almost 400%, and the BIX bank stock index 176% over this period.
Are the markets saying that, although the Bible states that "the truth shall
set you free", there's no guarantee that lies won't make you a lot more money?
After having preliminary results dribble out all week like baby food from an
infant's mouth, and after reports appeared in the press indicating that the
Treasury, under pressure from the banks, was amenable to changing the results
to be more favorable to the banks, the actual stress test results were released
on May 8.
They showed that the government believed that, to meet the most pessimistic
scenario, the banks would need $75 billion more in capital. Bank of America was
said to be the most needy, needing $33.9 billion to fill a hole in its balance
sheet opened up by losses in what the report called "trading and derivatives";
that is, everything that we now know the banks used to love doing that they
shouldn't have been doing. Wells Fargo needed $13.7 billion to deal with its
problem first mortgage loans. Nine financial institutions, including State
Street Bank, JP Morgan, Met Life, and (of course) America's version of the
Vatican bank, Goldman Sachs, were said to need no help at all.
The reaction to this news on Wall Street was a jubilation not seen since the
Street's nemesis and former New York governor Eliot Spitzer was led out of his
per hour paramour's Washington hotel room in shame. Just last week, as the
results leaked to the press, Bank of America was up 87%, Wells Fargo 36%, the
BIX up 34%.
Why the elation? I heard more than a few market commentators opine that it was
due to a feeling that Geithner had morphed into Alexander the Great and had at
last cut the Gordian knot. The problem of bank toxic mortgage and other
collateralized assets that had bedeviled the markets for coming up on two years
now had finally been solved, and, much in contravention to what spoilsports and
worrywarts like me have been saying, the problem's not all that massive to
begin with.
In no way were the problems so vast as to necessitate a nationalization of
parts or all of the financial system, a particular bugaboo for stock traders.
More than a few commentators observed that, what with the banks' problems now
seen to be so manageable, repayments could soon commence of the despised and
accursed Troubled Asset Relief Program (TARP) money taken from the government
in the form of preferred stock last October.
In exchange for almost $200 billion in federal money, the banks were subject to
executive pay and compensation limits, such as pay caps of around $500,000 a
year, that were placed into law with the February stimulus package. Even
considering the fact that the banks would not be able to borrow on their own at
the 5% coupon rate they were paying the government for the preferred, the
bankers considered such outrageous restrictions on their personal freedom a
human rights travesty reminiscent of a Khmer Rouge death march.
Just the prospect of the end of the demonic TARP limits probably made the
bankers want to at last don their $400 climbing shoes purchased at REI but
never worn to ascend to the top of the rock wall at the gym and smash it with
pickaxes, to celebrate their freedom from oppression much as the youth of East
Berlin did in November, 1989. If they couldn't do that, they would celebrate
their freedom with a pyrotechnic display of bank stock buy orders.
But then, from little home studies off the laundry room, and from little poorly
lit desks in the corner of the bedroom where the spouse is sleeping, the
resistance stirred and awoke - the worldwide economics and finance blogger
punditocracy took apart the stress tests. Down and down they burrowed, looking
for any kernels of truth underneath all that bureaucratic verbiage. When they
couldn't find it, they naturally assumed that it was never really there in the
first place.
Particular among the contributors to the debate were Yves Smith of the Naked
Capitalism blog, and the anonymous blogger who posts on the Calculated Risk
blog. These and others took apart the stress tests so thoroughly that, by the
time the weekend was barely half over, Geithner's beautiful free-market
tapestry was looking about as shabby as a hobo's sleeping blanket.
Many times on these pages (see, most recently,
Bankers get a model rush, Asia Times Online, April 9, 2009), I have
expounded on how bankers wanted what they considered to be a horrendous
accounting standard called "mark to market" replaced. What mark to market did
was to force the bank to report the value of its assets, its loans, to be
exactly what they would command in the secondary markets - nothing less,
certainly no more. In early April, the accounting industry loosened the rules
for mark to market, allowing it to be supplanted by the much looser
mark-to-model standard. In none of the stress tests was any mark to market
accounting of banks' assets utilized; mark to model was how the auditors valued
bank assets, and the good times rolled.
Other observers noted that the auditors seemed very reluctant to do much
analysis of the burgeoning problems in commercial real estate. This crisis
began with problems in residential real estate and the financial problems that
arose out of it. Now, many observers are saying that most of the bad news
originating in home finance has passed - now it's time for a more serious
analysis of the many vacant office parks and storefronts of commercial real
estate, and how the bad loans advanced to these endeavors will soon
detrimentally affect bank earnings.
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