NEOAVATARA

The Treasury Department’s ‘stress test’ of the major American banks should come to conclusion this week.  Timothy Geithner has an editorial in the New York Times describing the process.

Geithner explained how the process worked:

The Federal Reserve marshaled hundreds of supervisors to spend 45 days rigorously reviewing the banks’ detailed loan data. They applied exacting estimates of potential losses over two years, along with conservative estimates of potential earnings over the same period, and compared them with existing reserves and capital. The results were then evaluated against strict minimum capital standards, in terms of both overall capital and tangible common equity.

Rumors have swirled for days that Bank of America, Citigroup and Wells Fargo may need billions to be stabilized.  Leading the list of companies that need more capital was Bank of America, which faces a $33.9 billion shortfall. Following behind was Wells Fargo and struggling auto finance firm GMAC, which will need to raise $13.7 billion and $11.5 billion respectively.  Beleaguered banking giant Citigroup, which has taken hold of approximately $50 billion in government aid to date, is being asked to raise $5 billion, regulators said.  Five regional lenders — PNC, Regions Financial, SunTrust, Fifth Third and KeyCorp will also be required to raise new capital. So will Wall Street investment bank Morgan Stanley, which regulators said would require $1.8 billion to shore up its capital position.

Tjhese banks will have to raise money, either by borrowing or issuing more stock.  If they are unable to raise the money, the government will convert its preferred stock holdings into common stock, to leverage their bailout money.

That is all well and good.  And I agree with the Obama Administration that something of this sort had to happen, because there was no trust of the banking sector by the public.  Some outside entity had to give a verification of where we stand on fiscal soundness of the financial sector.

But what now?

Certainly, there will be a TARP II, or whatever the Obama Administration will call the program.  Entities such as Bank of America are the classic ‘to big to fail’, and need billions to stabilize.

The most interesting will be Wells Fargo.  They are actually profitable right now.  And the C.E.O. has said that they actually never wanted TARP funds in the first place, and were forced into taking the funds.   Wells Fargo has said they will issue more stock to raise cash.  They intended to pay back the monies before the stress test.  Now, however, the government has determined that they need more funds to stabilize…even though are profitable.

Huh?

What will make it even harder to swallow is that the Obama Administration is pushing for the CEOs of companies failing the stress test to resign.  Nothing strikes fear faster into Wall Street Executives faster than more government intervention.  Additionally, why should profitable companies fire their CEOs?  Doesn’t make any sense.

Now, there is a caveat.  I think this is the fork in the road for banks.  I think the government should give the banks a choice.  If they want TARP funds, so be it; but it comes with strings attached.  If they don’t, that should be fine as well, but then they should not be under any delusions of government help down the road.

So the answer to my intial question, did the stress test accomplish anything?  The answer is yes.  It does evaluate where the banks stand as of now.  And for the markets, that is a key indicator for moving forward, and forebodes improvements in the financial sector in the future.  But, it by no means ends the discussion, because in many ways it produces more questions than answers.