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Manipulated Bank Stress Test Reveals Only One Bank in Trouble?

Politics / Credit Crisis Bailouts Apr 28, 2009 - 11:55 AM GMT

By: Money_Morning

Politics

Best Financial Markets Analysis ArticleWilliam Patalon III writes: Only one of the 19 financial institutions that received a bank stress test would require additional capital, the controversial government initiative has reportedly concluded. The identity of the bank that is alleged to have failed the bank stress test was not revealed.

The bank-stress-test findings were reported yesterday (Sunday) by CNBC.com, which said it obtained the information from a source that it did not identify. The source did not identify the company, CNBC.com reported.


“At least one firm – under the [bank] stress test assumptions – will require more capital,” the source said.

The bank-stress-test results were contained in a two-dozen-page report that the government released Friday. But the results had already been “conveyed” to the firms, meaning the bank in question is aware of the U.S. central bank’s assessment, according to the published report.

This round of bank stress tests was essentially a two-step process. The first step – outlining how the banks have been analyzed – was taken care of with the report released over the weekend.  The second step – releasing the results to the public – will be taken care of when the actual results are released May 4, which is one week from today (Monday).

Neither the U.S. Federal Reserve nor the U.S. Treasury Department would comment.

The bank stress tests have a very specific purpose. Financial institutions that are found to have inadequate capital will have six months to raise the money via the private sector. If that doesn’t work, the government has said the financial institutions will be eligible for an infusion of capital via the federal government’s so-called “Capital Access Program.”

U.S. Treasury Secretary Timothy F. Geithner said he would be open to banks repaying their Troubled Asset Relief Program (TARP) loans, as long as the availability of credit (borrowing) was not adversely affected.  As a Money Morning special report detailed last week, the credit markets don’t seem to be loosening up: Lending dropped by more than 20% from October 2008 to February 2009, despite initiatives to encourage such activity.

According to the conclusion of the report released over the weekend, “most banks currently have capital levels well in excess of the amounts needed to be well capitalized.”

However, as Money Morning has reported, the tests have become a “no-win” situation for the Obama administration.

“There are two things that are terribly wrong,” William M. Isaac, the Secura Group chairman who served as head of the Federal Deposit Insurance Corp. (FDIC) from 1981 to 1985, told CNBC.com. The first problem – and a big one – is the fact that the details were announced at all.

“I can't imagine what Treasury was thinking when it made that move. It has been causing incredible angst in the markets,” said Isaac. “The second big problem is that the Treasury is directing the stress testing, apparently with direct involvement of the White House at the highest levels. Bank regulation by law is supposed to be carried out by the independent banking agencies without any political interference.”

Market Matters     

As Money Morning reported Friday – in a Wall Street version of the old “he said/(s)he said” drama, Bank of America Corp. (BAC) Chairman and Chief Executive Officer Kenneth Lewis claimed that ex-U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. and central bank Chairman Ben S. Bernanke threatened to remove him from office if he backed out of the Merrill Lynch & Co. Inc. (SQD)  merger or (publicly) discussed the mounting losses.

Paulson had previously testified that Lewis must have misinterpreted their comments, but then seemed to blame Bernanke for the threat (Translation: Paulson tried to throw Bernanke “under the bus.”).

New York Attorney General Andrew M. Cuomo has been investigating the activities surrounding the merger to determine why shareholders were kept in the dark about the financial “challenges.”

Shifting to autos, Italy’s Fiat SpA (OTC ADR FIATY) emerged as a potential major global player as it attempts to forge a partnership with (soon-to-be-bankrupt?) Chrysler LLC, and also has interest in buying General Motors Corp.’s (GM) Opel unit. Meanwhile, GM will be closing 13 production plants over the summer to trim inventory and seems likely to miss a $1 billion debt payment due June 1 as it too moves closer to bankruptcy protection.

How bad is GM’s plight: GM may close its Pontiac division after 82 years of operation, The Wall Street Journal and MarketWatch.com reported over the weekend.

While the earnings news of the week found plenty of winners and losers, ultimately analysts perceived a bit of “cautious optimism.”  Bank of America and Morgan Stanley (MS) failed to live up to the favorable showings by Wells Fargo & Co. (WFC) and other financials, though techs like Texas Instruments Inc. (TXN), Apple Inc. (AAPL) and International Business Machines Corp. (IBM), beat Wall Street expectations, and brought new hope that the downturn was nearing an end. (Watch for an updated “Hot Stocks” feature on IBM here in Money Morning later this week).

Unfortunately, Microsoft Corp. (MSFT) posted the first quarterly revenue decline in its 23-year history, though investors still cheered its ability to reduce costs during these challenging times for PC sales. McDonald’s Corp. (MCD), AT&T Inc. (T), and Ford Motor Co. (F) were among the diverse group of companies reporting better-than-expected results, while United Parcel Service Inc. (UPS), Caterpillar Inc. (CAT), and Continental Airlines Inc. (CAL) issued disappointing numbers.

Amazon.com Inc. (AMZN), the subject of a recent “Buy, Sell or Hold” feature here in Money Morning, bucked the negative trend facing many retailers and posted higher quarterly earnings and revenue.

Additionally, U.S. retailers J.C. Penney Co. Inc. (JCP) and Coach Inc. (COH) each expressed positive sentiment that sales activity seems to picking up.  Oracle Corp. (ORCL) snapped up Sun Microsystems Inc. (JAVA) for $7.4 billion after IBM chose to pass, and PepsiCo Inc. (PEP) is attempting to purchase two related bottling companies as corporate execs seek favorable deals in this environment.  Such merger-and-acquisition (M&A) transactions often signal boardroom confidence and also indicate that the “worst” part of a downturn may be over. 

Oil prices surged above the $51-a-barrel level late in the week as traders overlooked the higher inventory levels and instead focused on some favorable signs that the economy may be closing in on turnaround mode.

With a six-week winning streak on the line, investors offered their best “clutch hitting” late Friday, pushing all major indexes to higher levels. Early in the week, after investors digested negative news from the likes of Bank of America and GM, prognosticators said the weekly stock-market winning streak was all but over. However, some better-than-expected earnings and economic reports brought out the “bulls” for one final run.  The Nasdaq Composite Index ended the week in positive territory, and the other equity indexes were virtually flat from last week’s closing levels (with the Dow Jones Industrial Average suffering a slight decline). 

Market/ Index

Year Close (2008)

Qtr Close (03/31/09)

Previous Week
(04/17/09)

Current Week
(04/24/09)

YTD Change

Dow Jones Industrial 8,776.39 7,608.92 8,131.33 8,076.29 -7.98%
NASDAQ 1,577.03 1,528.59 1,673.07 1,694.29 +7.44%
S&P 500 903.25 797.87 869.60 866.23 -4.10%
Russell 2000 499.45 422.75 479.37 478.74 -4.15%
Fed Funds 0.25% 0.25% 0.25% 0.25% 0 bps
10 yr Treasury (Yield) 2.24% 2.68% 2.93% 3.00% +76 bps

Economically Speaking

According to the International Monetary Fund (IMF), the global downturn will be far worse than previously expected.  For 2009, the IMF expects the world economy to contract by 1.3%, its first such decline in 60-years, with over 10 million employees losing their jobs.  Unfortunately, its projections for the United States are even more dire (-2.8% for the year), with domestic financial institutions suffering $2.7 trillion in losses, almost twice the IMF’s prior estimates from just six months ago.   

While much of the economic data of the week confirmed the IMF’s weak projection, analysts found a few positive signs that the downturn very well may have bottomed out.  While both new home sales and durable goods orders declined in March, the results beat the weaker Street expectations and came in the aftermath of some (relatively) strong February numbers.

In another promising sign of stability within the housing sector, the median price of an existing home sold in March actually rose for the second straight month.  Still, the record unemployment filings last week revealed the ongoing difficulties facing job seekers amid these tight labor conditions.  Likewise, leading economic indicators, a predictive report, dropped for the third consecutive month and many economists expect the recession to last at least until late third quarter. 

Weekly Economic Calendar

Date

Release

Comments

April 20 Leading Indicators (03/09) 3rd consecutive monthly decline
April 23 Initial Jobless Claims (04/18/09) Highest level of total claims ever reported
  Existing Home Sales (03/09) Larger than expected decline in resales
April 24 Durable Goods Orders (03/09) Lower than anticipated fall in orders

 

New Homes Sales (03/09)

Drop in sales though better than expected results

The Week Ahead    
April 28 Consumer Confidence (04/09)  
April 29 GDP (1st qtr)  
  Fed Policy Meeting Statement  
April 30 Initial Jobless Claims (04/25/09)  
  Personal Income/Spending (03/09)  
May 1 ISM – Manu (04/09)  

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