Stress Tests - The Real Story - 4 / 4 / 2009

Six months ago a close associate of mine who was working as a NASDAQ trader for a top 10 Investment Bank in NYC received a call from a former employer. This employer was in desperate straights. They needed former analysts who knew their internal process, systems, and models to come back to work for them on the largest financial project in their history. It did not matter that my close friend had left that job 15 years ago and had done nothing but sell NASDAQ blocks in the interim. They would match his salary, give him better benefits, long time job stability, and offer him an inside look on the US and World economies every day. Since the NASDAQ was cratering in October and most traders were getting the axe, he rejoined his former employer, The New York Federal Reserve Bank.

I shared a cocktail with him 8 weeks later on New Years Eve and the subjects of Citibank, Wells Fargo, Wachovia, B of A, and Merrill came up. His statement shocked me. He said - It is so bad, I am being told that all major banks are insolvent by our standards. That no one has a clue how bad it will get, and that teams were being formed to monitor all domestic and international money center banks, analyze them, and provide recommendations on how they might be saved.

We all know the rest, in January and February word began to leak on what the Fed was up to. Financial stocks dropped dramatically, and the Fed and the Treasury used every available means to stop the bleeding. But, we were told, "stress tests" were being launched and results were a few weeks away.

Here we are, May 4th, and the results of the Stress Tests have yet to be released. Well folks, here is my best guess as to why these results are being delayed further and further every day. -

I think the answer is obvious here - The results are in, and the government is cutting back door deals with banks that failed the tests so they can announce that all banks they tested have either passed or been stabilized. There are more banks that failed the tests than the Fed wants to admit to. Some are foreign banks. Some are foriegn government subsidized banks. The real pandemic out there is the weakness of all the world's national and money center banks. And the US government and G - 7 equivalents are trying like mad to cut back room deals among any party that will participate in an effort to shore up the banks that did not pass.

Once this has been done then we will get a public announcement. It's just a repeat of October's insider deals between Wells Fargo, Citigroup, Wachovia, Countrywide, Berkshire, Merrill, B of A. The government is just being more careful this time given the results of the B of A / Merrill forced deal.

These, folks are trying times, and I believe that in addition to the back room stabilization deals, the Government is also waiting to see where this interim capital markets rally ends. They are afraid that a stress test results release without proper solutions and fixes in place for weakened banks, will cause more capital markets panic and a reversal in recent optimism.

I believe the capital markets came to this conclusion 2 weeks ago and the capital markets have no real fear of unknown weakness in money center banks. They know already that the world's reserve banks will not let another crucial bank tank. If nothing else, the US Government understands the sentimental connections by and among banks, corporations, and the equities markets - a trick picked up from the Greenspan Era - and recognizes it is a tricky path to walk. So they will most certainly hedge their bets and stabilized banks that failed their stress tests ahead of announcing any stress test results. Let's hope that the deals they are making do not weaken more banks. Because one thing is for certain, this Fed is running out of silver bullets. You want an answer as to why the capital markets seem to be ignoring bad news? You at least have my answer.

Build Value Every Day

Brad van Siclen