Treasury hangs out Wall Street's dirty laundry

The stress test report card includes the government's best guess as to how badly the financial crisis will pummel the biggest banks. But no one knows what's really going to happen.

By Andrew Leonard
Published May 7, 2009 10:24PM (EDT)

If you add the amount that U.S. banks have already lost as a result of the financial crisis, according to the U.S. Treasury in its fresh-off-the-Web server report of the stress test results -- around $400 billion -- to the total the government thinks the biggest banks stand to lose in the next couple of years under an "adverse" economic scenario -- around $600 billion -- you get a cool trillion dollars. This is remarkably close to the $1.06 trillion number estimated by the International Monetary Fund in its recent Global Financial Stability Report.

That may provide some comfort to critics who are convinced that the whole stress test operation is an orchestrated whitewash, meant to obscure deep insolvency in the banking system. But at least now the critics have some numbers to crunch. The stress test report card includes a detailed breakdown of estimated losses for each of the 19 biggest banks in the U.S. It's safe to say that there's never been a more public presentation of Wall Street's dirty laundry than what the the U.S. government had paraded out for all to see today. (The exact amount of capital buffer additions recommended for each of the 10 banks that "failed" the stress test can be can be found here.)

The report is careful to stress that the estimates are not "forecasts or expected outcomes" but the results of "what-if" scenarios -- a baseline scenario and an "adverse scenario." As such, it is inherently speculative in nature:

Not only is it virtually certain that the economy will not evolve in lockstep with either of these scenarios, but there were also other factors that had to be assumed constant for the purpose of conducting this exercise, and any of those factors could change materially from what was implicitly or explicitly assumed in this process.

But the point most critics will jump on is the question of just how "adverse" is the adverse scenario.

From the first paragraph of the 38-page Supervisory Capital Assessment Program: Overview of Results, aka the "stress test results (italics mine):

During this period of heightened economic uncertainty, U.S. federal banking supervisors believe that the largest U.S. bank holding companies (BHCs) should have a capital buffer sufficient to withstand losses and allow them to meet the credit needs of their customers in a more severe recession than is anticipated.

From the second paragraph:

This unprecedented exercise ... allowed supervisors to measure how much of an additional capital buffer, if any, each institution would need to establish today to ensure that it would have sufficient capital if the economy weakens more than expected.

Anticipated by whom? Expected by whom? Treasury, of course -- and not Paul Krugman or Joseph Stiglitz or Simon Johnson or a host of other observers who are convinced that the biggest banks in the United States are teetering on the edge of bankruptcy. For them, the adverse scenario has already become the baseline scenario, and things could still get a lot worse.

Then again, they might not. As noted earlier today, there are some signs that the economy might be poised for a (weak) recovery. In that case, says Treasury, the banks that bolster their capital buffers "will still be viewed as stronger today for having higher levels of capital in an uncertain world."

The total amount of capital Treasury believes the 10 weaker banks need to raise -- in addition to what they already have -- to be prepared for further losses is $75 billion. Ideally, Treasury says the banks are "encouraged to design capital plans that, wherever possible, actively seek to raise new capital from private sources."

We'll soon see how realistic that option is. We'll also soon see, as early as tomorrow, whether the details released by Treasury concerning the balance sheets of each of the big banks impel traders to dump stock in those banks tomorrow. And now, once again, Wall Street's attention will refocus on the Geithner plan to get "toxic" assets off the balance sheets of these banks. It is impossible to say, at this juncture, whether the Obama administration's strategy will work, or backfire disastrously. But what does seem pretty clear is the general determination to proceed along the outline laid out in February. We have yet to see the about-face reversals and zigzags that characterized the Paulson Treasury regime. That alone can be seen as a positive development, can't it?

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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