It’s Judgment Day for the nation’s largest banks.
Although the news about the bank stress tests have been dripping out, the official results of the government’s financial stability examination will be released today after the stock market closes.
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While it looks like the banks will be compelled to add tens of billions of dollars in cushions to guard against an even deeper recession, Wall Street appears comfortable with the results. Over the past week, bank stocks have seen gains across the board.
The idea behind the tests was to determine whether the major banks could handle the worst of the economic fallout.
To avoid a panic, the outcome relating to each individual bank was to be kept confidential, with only a general release about the overall results. Given the porous nature of Washington and the hunger of investors to know, the widespread release of the detailed results was a foregone conclusion.
The Bad and Getting Worse News
At the top of the list, Bank of America will have to raise an additional $34 billion. Citibank and Wells Fargo each will need somewhere in the neighborhood of a $10 billion cash infusion. J.P. Morgan Chase and Goldman Sachs seem to have come through the regulatory spin cycle unscathed. Both appear to have adequate liquidity to meet the financial challenges ahead.
Instead of perpetuating an atmosphere of continued anxiety, the tests have had the opposite effect.
They have been a market confidence-builder. The results may not be a clean bill of health for the country’s largest banks, but the findings have been a counter to the gloom and doom mentality that has gripped the markets over the last several months.
The bottom line, according to Treasury Secretary Tim Geithner, is that none of the banks is facing insolvency. At this point, none of the banks will be compelled to surrender more of their stock to the government in exchange for further financial assistance.
A Necessary First Step
In place of the further taxpayer assistance, the banks are required to first look to private investors to fill their financial gaps. Theoretically, if these banks are unable to secure the funding they need from the private sector, the government may step in with additional bailout monies.
This is not the scenario that the federal regulators presently foresee or that the banks appear to want.
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To meet their cash needs, several of the institutions probably will start selling off many of their subsidiary units. More than a few private equity groups and hedge funds are anticipating fire sale-style bargains as the banks break off chunks of their businesses to raise cash.
In the end, to avoid further government intervention, the banks are being forced to return to their core business of saving and lending.
Treasury and the Fed also have used the vehicle of the stress tests to a shine broader spotlight on the need for overhaul banking regulations and oversight. Over the coming months, it’s a sure bet that the government will announce strict regulator changes to everything from bank employee compensation to risk management.
This banking crisis has revealed serious deficiencies in the government’s ability to monitor risk-taking, capital adequacy and liquidity planning on behalf of the banks.
To avoid these shortcomings going forward, the Obama administration now has the green light to aggressively beef up the ranks of its regulators. This means that federal agencies, like the Office of Thrift Supervision and the FDIC. no longer will be a backwater for business school graduates rejected by Wall Street, but the first stop on the resume for some of the best and the brightest.
None of these changes will help the banks avoid the additional billions in mortgage-related losses they are projected to incur over the next 18-months. But it does provide a clearer picture of what they must do to stay afloat until the stormy financial waters calm.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
