The stress tests are more of a mid-term exam than a final one for the 19 biggest financial institutions and the government results due out Thursday may not do much to end the uncertainty over the financial health of the banking industry.
In fact, experts say, the results may only be the beginning of a long and arduous process.
“They don’t want to scare people, so they say the banks need capital but are not in desperate shape,” says Robert Glauber, who oversaw the Treasury’s bail out of the savings and loan industry two decades ago and is now serving as interim non-executive chairman of Freddie Mac.” My own view is that they are worse off than they say they are.”
Perhaps by no coincidence, government officials who worked through the S&L crisis are among the most skeptical about the stress test process and the results.
Lawrence White, a former regulator and White House economist, calls it a sham, adding. “One way or another, it’s pay them now or pay them later.”
While Wall Street has been following the trickle of leaked stress test results like a sports match or a Las Vegas betting sheet, there’s been little focus beyond the names and numbers of the banks and capital needs.
It’s almost as if the results of the tests have become an end to themselves, instead of a means to an end, say industy watchers.
Veteran banking analyst Bert Ely scoffs at the notion that “the results will end uncertainty.”
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“They may be able to mange it [expectations] the day of the announcement,” adds Gerald P. O’Driscoll Jr., who worked at the Fed and Citigroup. “People are going to start asking, 'Where are the banks going to get the capital?'”
That's especially relevant given that the government's TARP fund had dwindled to less than $100 billion and Congress seems strngly opoised to approving any additional bailout money.
And therein lies the rub. Observes say both the government and the banks will need to unveil something of a plan along with the results.
That will need to go beyond the previously articulated concept of giving the banks six months to raise capital from private sources before tapping the government's new TAP program for more money, as well as the assumption that banks can quickly and easily raise cash by converting preferred stock to common shares.
“I think that Treasury needs a clear path forward,” says economist Dean Baker, co-director for the Center for Economic and Policy Research. “Presumably, they will have a path described which the banks will follow (some mix of public and private capital). The path may not be entirely credible, but they have to be at least able to say something about how they will set things right.”
There’s significant debate about how detailed that plan should be, how quickly all the details need to be disclosed and how much of it needs to be made public, but there’s general agreement a plan is needed.
“My sense is they'll talk about it in terms of options for these companies in terms of being well-capitalized,” says Ely, who suspects some of that has already taken place with the banks behind closed doors. “They’ll be a six-month plan; based on what we know today you have to do a, b, ,c, d.”
“The government will give them a short time to come back with an action plan," says Glauber. “I think it should be two weeks.”
In the meantime, the banks involved may be pressed to explain whatt hey can to investors and analysts in conference calls.
Options would include asset sales and even friendly takeovers. After all, tapping private capital without having to yield a big discount may not be as easy as either the industry or the government have suggested, say banking analysts.
Given current circumstances, the stress tests are likely to yield surprises.
More consolidation is one of them. It may be no coincidence that JPMorgan Chase (NYSE: JPM) boss Jamie Dimon mentioned the possibility of new acquisitions this week.
“I think we can see some deals announced pretty quickly,” adds Ely. “The market has beaten their price down so much, some won't be able to remain independent..”
Analysts say the smallest of the banks involved in the tests are the most vulnerable and likely takeover candidates.
“If they had to raise a lot of equity they would probably have to fall into the arms of someone else,” says FBR Capital Markets banking analyst Paul J. Miller.
Neither analyst would name names, but based on size those firms would include First Third, Keycorp, Regions Financial and SunTrust.
And though those such deals may not be orchestrated by the government in a high profile way as they were in the past with Merrill Lynch, Countrywide, Wachovia, Washington Mutual and Bear Stearns, few doubt Washington won't give its blessing.
“They’re picking winners right and left,” says White, now with NYU’s Stern School of Business.
“I don't know what to expect, but I sure hope it's not more shotgun weddings,” says former FDIC Chairman William Isaac. “We don't need more concentration in banking and ever larger firms.
List of Stress Test Companies:
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