Monday, May 11, 2009

The Fed Plays Softball with the Banks

Someone at the Fed didn’t get the word. This deluded individual thought the bank stress tests were about evaluating the banks’ ability to survive a further downturn in the economy.

Wrong!

The stress tests were part of an elaborate PR campaign to restore investor confidence by pretending that terminally ill banks are hale and hearty. According the to the weekend edition of The Wall Street Journal,

The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation’s biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

Of course they did. You can’t go around scaring investors by telling the truth. For example, the original stress test showed Citibank with a gaping $35 billion capital hole. This simply wouldn’t do, so the hole miraculously shrank to $5.5 billion.

According to the paper, “Bank of America was ‘shocked’ when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.” So, the Fed obligingly reduced it to $33.9 billion.

The paper then reassures us that, “Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests’ rigor.”

This is like a court of law being responsive to a criminal’s feedback when it comes time to sentence him.

Apparently, the Bank’s derivative holdings were not a factor when conducting the tests. Writer Mark Whitney quotes F. William Engdahl who points out that five U.S. banks hold 96% of all US bank derivatives. These are the credit default swaps everyone is talking about.

JP Morgan Chase is sitting on $88 trillion of these babies, with Bank of America holding $38 trillion and Citibank with $32 trillion.

But, Bernanke assures us that the banks are healthy.

Of course they are. Any corpse looks healthy if you rub enough rouge into its cheeks.


--Belacqua Jones

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