Friedrich von Blowhard writes:

Dear Blowhards,

According to unnamed "officials" of the Obama Administration, we will shortly hear the new new plan to save the “too big to fail” banks. From a Sunday CNBC story, "Crafting a Bank Plan...No 'Lehman Weekends,' we get this choice tidbit:

Officials would not rule out increased or even outright government ownership of large banks at the end of the process, but they say their intent is to avoid that outcome and that it is anything but certain. They say the government does not want to be running these companies.

If the banks end up in government hands, officials say, the intent would be to get them into private hands quickly and do so in a way that is not much different from how the Federal Deposit Insurance Corp. currently resolves bank insolvencies, which typically take place over the weekend. The extent of government ownership, they say, will depend on the size of the losses at the banks, the access of banks to private capital and how the recession plays out.

Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.” [emphasis added]

I hope you noticed the odd slip there, which is public admission that the so-called bank "stress tests" are not designed to actually find out anything. Rather, their purpose is to serve as propaganda, informing the U.S. taxpayer and stock market investors of the predetermined outcome that everything with the banks is hunky dory and handing over many more billions to them is in no way sending good money after bad.

What sounded like the most (only?) valuable part of Secretary Geithner’s plan – that is to say, a pulling aside of the information iron curtain that has prevented the U.S. taxpayer from being able to get any accurate view of what condition the balance sheets of these extremely peculiar, must-be-bailed-out-no-matter-what-the-cost banks are – has now been revealed as bunkum.

Actually, Yves Smith of Naked Capitalism back on February 17 had already pegged the impossibility of performing such stress tests meaningfully in the time span discussed by the Administration. You should read the whole discussion, "William Black:There Are No Real Stress Tests Going On."

Mr. Black, a former high bank regulator, goes into far more detail, but in capsule, as I understand it, the issues preventing such an appraisal include:

1) You can’t perform a stress test on securitized loans (representing hundreds of billions of dollars on the too-big-to-fail banks’ balance sheets) unless you have access to all the paperwork of the original loans, and it is very unlikely that it is available to regulators. In fact, Mr. Black has dark suspicions that much of it (especially for loans originated by hundreds of now-bankrupt mortgage mills) may no longer exist.

2) If the banks are actively trying to hide losses, it would take many times the number of examiners actually available to the FDIC to realistically determine the true financial position of the banks. Given the actual numbers of examiners available for such a task, such a stress test will merely consist of repeating to the public what the banks tell the examiners. As Warren Buffet remarked in a different context, the stress test will obviously be a self-graded exam, with the penalty for failure being death. How likely is that to produce honest figures?

3) The number of bank examiners that can meaningfully stress test the most elaborate securities is approximately zero. This isn't really a criticism; it appears that no one on Wall Street really understands a good deal of this junk, or they would be buying it happily for a risk-free profit, which they are most assuredly not doing.

4) To objectively evaluate the results of any stress test, the government would have to publicly publish its analytic criteria in detail; guess how likely that is to happen. Even if it were to happen, enormous arguments would then ensue about the criteria chosen; I’ll let you figure out which side the banks would come out on.

So at the end of the day, the new new plan will provide us with evidence that it is safe to do what the Obama Administration has already made clear it wants to do. That is, avoid public ownership of large banks despite the massive public investment already made in them and the likelihood that further such investments will occur. In short, reality be damned, we’ve got the stress tests (which we designed and graded)!!

I figure that should keep us pathetic taxpaying citizens safely in the dark for another month or two while more hundreds of billions of our dollars go wafting over to Wall Street, what do you think?

Cheers,

Friedrich

P.S. This morning Ms. Smith of Naked Capitalism makes more or less the same point I do in her post, "Now It's Official: Stress Test Results Pre-Determined", but adds two items. First, Citibank with in excess of $2 trillion in assets is being 'stress tested' by all of 100 examiners...giving each examiner a mere $20 billion in assets to examine under any and all foreseeable market conditions. (And not lollygag about doing it, either.) The second item is an anecdote lifted from a comment by one one reader on what kinds of loans haven't yet been classified by Citi as officially troubled, which will presumably be totally ignored by the examiners, given how meagre the resources they have to work with:

I have a personal anecdote about Citi and the difficulty of spotting how bad their loans actually are. I'm involved with a $300 million condo-hotel development in the Caribbean. Citi has the whole loan (i.e., they didn't securitize or otherwise sell participations in the loan). Even now, we expect the hotel needs at least another $100 million to finish construction and open (we are no longer under any delusions that more than a handful of buyers will close on the condo portion of the condo-hotel). So, in other words, Citi is $275M into this project, and it's not certain that the completed hotel will even be worth the extra $100M required to complete and open. Hence, one might plausibly value this $275M loan at zero (i.e., a complete write off). I cannot imagine any stress test would uncover what a huge loss is on the way in the next 12 months. In fact, this loan has not even been pawned off to the nonperforming/distressed debt/workout section of Citi because the interest reserves make it "seem" like the loan is still performing, not to mention that completely out of date pro formas make it "seem" like (i) equity will come in to finish the project and (ii) condo sales will pay down a huge part of the principal once construction is complete. This scenario must be present in a large number of Citi loans, especially in their somewhat active foreign development divisions. Citi must be so far from solvent that it's not even funny. Only hyperinflation in the dollar could ever make it possible for the borrowers to pay back some of these loans. I'd bet that the sooner we face reality on some of these loans and just halt future fundings, the less money the taxpayers are going to lose. As it is, it's almost too late. Too bad for the US taxpayer.

I wonder if Secretary Geithner and the other Rubinauts of the Obama Administration will take detailed questions on issues such as this? What do you guys think?

Let me play ironical contrarian (not that I know anything) but who, ultimately, gets all this bail out money, if Citi somehow survives? The Citibank shareholders and bondholders? But who are they -- or, rather, are they us? Pension plans, 401K's, etc? Trillions of dollars are going up in smoke, and not even the billionaires have most of that. Heads the taxpayers lose, tails the taxpayers still lose.

I am not sure I really believe this, but I wonder.

Posted by: Luke Lea on February 22, 2009 10:28 PM

Luke, you can be confident that the people who gain the money are not the very same people who paid it, and in the same amounts. Because then there would be no incentive for all this elaborate shakedown. Maybe it's all a scam to enrich the American Ruling Class, or at least to reduce their losses. Or maybe it's an attempt to persuade China, Saudi etc not to pull the plug. (But could they anyway?) Whatever is going on, it's hard to believe it's constitutional, but when did anyone last care about that? The outlook is very bleak.

Posted by: dearieme on February 23, 2009 9:06 AM

Luke - The biggest beneficiaries are the holders of the big banks' preferred stock and debt. These are mainly insurance companies, pension funds, foreign sovereign wealth funds, and big investors like Warren Buffett. So you can think of this as a transfer from the taxpayers to those investors, with a side payment to bank executives. Most companies having converted to 401ks, a large fraction of the pension funds are public employee funds.

Posted by: pj on February 23, 2009 2:44 PM

The anecdote about the Caribbean condo/hotel is absurb. "we are no longer under any delusions that more than a handful of buyers will close on the condo portion of the condo-hotel." Uh, why? Basic economics says lower the price and they'll sell.

Lowering the price means Citi will get at least some of its' money back. Beats eating $275 million and leaving an unfinished project standing idle.

This mindset is the thinking behind Obama's mortgage bailout plan. Supporting struggling mortgage-holders only supports the unrealistically high price of the house. Let the house go into foreclosure. It will then go back on the market at a more realistic price and the bank actually gets a chunk of money. Same as what should happen to the Citi condos. In essence, let the market find its' own level.

Posted by: Bill on February 23, 2009 6:25 PM

You don't need exhaustinve paperwork to evaluate an overall portfolio. You just need to dive exhastively into select parts ("sampling"). This is standard methodology. Very possible.

Posted by: TCO on February 23, 2009 9:10 PM

I have to say, Friedrich, you were right about the Democrats. Yep, both sides are in bed with the bankers. It's funny; I'm thinking about becoming an anarchist or non-racist fascist or something.

Posted by: SFG on February 25, 2009 9:49 PM






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