Almost from the day that Treasury secretary Timothy Geithner announced that the government would be conducting "stress tests" on the nation's largest 19 banks, a vociferous horde of critics has assumed that the underlying strategy was to avoid facing up to the supposed "insolvency" of the banking system.
But now we know that regulators believe that 10 out of the 19 banks will need additional capital, with Citigroup requiring $10 billion, and Bank of America a whopping $34 billion. The banks are supposed to have six months in which to raise the capital from private sources, but nobody thinks Bank of America can pull that off -- which means that the government is likely to require the conversion of its preferred stock in Bank of America to common stock, and become a major voting-empowered owner of the company.
So after all the furor, the stress tests suddenly appear to have been conducted with some real rigor.
Even Naked Capitalism's Yves Smith, who has had literally nothing good to say about the Obama administration's handling of the economy, was forced to admit that "things are not as bad as I feared" although she still asserts that "Treasury designed a test that errs on the side of being too industry friendly."
But if this is friendly, I'd be hard put to imagine what a mean Treasury would look like. Bank of America CEO Ken Lewis seems bound to lose his job, and the government appears set to wind up, if not with effective control of the nation's largest banks, than at least with a significant influence upon their operation. We still have little clue what the government will do with that control, but for now, at least, maybe we can step back from the outright dismissal of the stress tests as a complete joke.
Of course, in the current climate, there's really nothing that Treasury can do without coming under fire from someone. Felix Salmon is upset at what he calls "the hamfisted way" Treasury is "leaking the stress tests... with each iteration worse than the last." (I'm not exactly sure why he assumes that all the leaks are coming from the government. Barry Ritholtz asserts, albeit without providing any evidence, that "the info was leaked by an executive at the bank.")
I don't blame the banks for being angry. They have hundreds of people making sure that they're well capitalized; Treasury then sends in a handful of wonks to look over the books and a few weeks later determines that they're off by $35 billion? That's quite a shortfall, especially when there's really no indication that Treasury is better at working these things out than the bankers are.
I fear that in the wake of these stress tests, Treasury will have created an atmosphere of antagonism and mistrust which is going to make it almost impossible to push through the kind of root-and-branch regulatory reform that's desperately needed. Without the banks' buy-in, no new regulatory structure is going to work -- but right now the banks have every incentive to hide things from Treasury and the regulators, rather than to work with them to strengthen the system as a whole.
For once, I think Salmon is off base. It's really not our job to worry about whether the banks are angry or not. They dug their own hole and without government help, we can be sure that at the very least, Citigroup would have crashed, a la Lehman Brothers, long ago. The banking lobby has already successfully crushed attempts to give bankruptcy judges the power to modify mortgage contracts, and played a historically crucial role in weakening the regulatory regime and thus facilitating the current mess. Far better that Treasury take a firm stance with them, than an overly conciliatory one. We don't necessarily need the banks to "buy-in." If we use the power that we will have by virtue of bailing out the banks again and owning large swathes of their common stock, we will be the banks.