Thursday, May 21, 2009

Casablanca and the Stress Tests

"The results of the government's stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup and Bank of America may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape. This would be good news of it were credible. ... Our [loss] estimates are RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. ... The hope was that the stress tests would be that start of a cleasing process that would lead to a cleansing of the financial system ... The stress tests' conclusions are too optimistic about the banks' absolute health, although their relative assessment is more precise, because consistent valuation methods were used. Still, with Thursday's announcement of the results, it shouldn't be a surprise when the usual suspects emerge. We fear that we are back to bailout purgatory, for lack of a better term. Here are some suggestions for how to extricate ourselves. ... And to mimize cost to taxpayers, banks must not be allowed to cherry-pick which legacy assets to sell. ... Second, the government should stop providing capital, loan guarantees and financing with no strings attached. ... For example, consider the fact that the government, while providing aid to the banks, did not restrict their dividend payments. ... Consider also recent bank risk-taking. The media has recently reported that Citigroup and Bank of America were buying up some of the AAA-tranches of nonprime mortgage-backed securities. Didn't the government provide insurance on portfolios of $300 billion and $118 billion on the very same stuff for Citi and BofA this past year? These securities are at the heart of the financial crisis and the core of the PPIP. If true, this is egregious behavior--and it's incredible that there are no restrictions against it. Third, stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses", my emphasis, Matthew Richardson and Nouriel Roubini (R&R) at the WSJ, 5 May 2009.

Yves Smith has a 5 May 2009 post at her Naked Capitalism about this piece, which hits the high spots, link:

Insolvent, interesting; the system as a whole and some large banks. What to do? Print money! What else? I disagree with the New York University professors. As long as the Fed exists it will suppress interest rates to real savers detriment and banks benefit, or subsidize banks. Only repealing the Federal Reserve Act or a German-style hyperinflation may end this. The banks will evade any rule while the Fed stands by, eyes closed, or having told the banks how to evade the rule, crafting it to facilitate evasion. "Round up the usual suspects", said Casablanca's Captain Renault. Indeed. R&R note Citi and BofA got portfolio insurance totalling $418 billion, yet engaged in "egregious behavior". Really? Is Zimbabwe Ben (ZB) so stupid he did not anticipate this? Or was this exactly what ZB wanted? You decide.


Anonymous said...

1) “Bank Liquidity, Interbank Markets, and Monetary Policy,” by Xavier Freixas, Antoine Martin, and David Skeie

A major lesson of the recent financial crisis is that the ability of banks to withstand liquidity shocks and to provide lending to one another is crucial for financial stability.

This paper studies the functioning of the interbank lending market and the optimal policy of a central bank in response to both idiosyncratic and aggregate shocks.

In particular, the authors consider how the interbank market affects a bank’s choice between holding liquid assets ex ante and acquiring such assets in the market ex post.

Freixas, Martin, and Skeie show that a central bank should use different tools to manage different types of shocks.

Specifically, it should respond to idiosyncratic shocks by lowering the interest rate in the interbank market and address aggregate shocks by injecting liquid assets into the banking system.

The authors also show that failure to adopt the optimal policy can lead to financial fragility.

Read the full report:

Independent Accountant said...

I've seen papers like this in the past. For my money, they are nonsense. Just Fedheads trying to rationalize the Fed's existence. I say we should kill this monster. We don't need it. I have no problem with bank failures. Even TBTF bank failures. What does "financial fragility" mean? It means banks may fail you think shouldn't. I see "dollar fragility", you see bank fragility. The Fed kills the banks or kills the dollar. It's that simple.

Anonymous said...

I'm not defending the Fed... no... I keep waiting for the shade of Andrew Jackson to come floating on the scene...

Stress tests?

Just because Basel set capital requirements doesn't mean ZB has to follow that... he just aggregates the TBTF balance sheets with the Fed's...presto --- well capitalized...

Yes... kill the Fed... it's time...

Independent Accountant said...



VBPOutSourcing said...

This entire situation is messed up. When the fed hands out this kind of money and and doesn't attach harsh regulatory measures, they will do what they want, i.e. try to buy the naming rights of a stadium for 400,000,000 or give away high end bonuses. It is a strange place we have found ourselves in. And not o sound anti-government, but the gov sticking their heads into every failing free market is creating an unfair trade and disrupting the nature of capitalism.