Stress Testes of Steel

I cannot explain how much I love that headline, and how hard I’m going to work to make it relevant.  So the stress test results [.pdf] came out yesterday, and revealed that, while none of the banks are currently considered insolvent, several of them could go that way if the government’s “more adverse” scenario of unemployment hitting 10.3% comes to pass.  So they’re asking 11 bank-holding companies to raise capital to meet their preferred “cushion” level.  Here’s the summary of who needs what, in billions, as per the Wall Street Journal’s colorful front page:

Bank of America: $33.9
Wells Fargo: $13.7
Citigroup: $5.5
GMAC: $11.5
Regions Financial: $2.5
SunTrust: $2.2
KeyCorp: $1.8
Fifth Third: $1.1
PNC Financia: $l .6
Morgan Stanley: $1.8
J.P. Morgan Chase, BB&T, Capital One, US Bancorp, MetLife, Goldman Sachs, Bank of NY Mellon, American Express, and State Street: $0
Having six months to raise new, private capital: Priceless.

Let me highlight the surprises:

• Wells Fargo needs quite a bit of funding to be adequately cushioned against any further decline in the economy.  The predictions for Wells are already being called overly optimistic by some, because Wells — like several of the passing institutions — is heavily invested in real estate that may go further south than the government’s prediction.  
• Capital One is not on the needy list — let’s hope credit card defaults don’t surpass the government’s more adverse scenario numbers (18-20% losses).
• The Citi number seems low — until you realize that they need to raise $5.5 billion IN ADDITION to the $45 billion from the government that they just converted to common stock and the $3.4 billion it just sold Nikko for.  So put them down for $50 billion and change.
• GMAC suuuuucks.  I’ve got another post on that one coming later, though.

So, what do you do, the day after the government tells everyone that you aren’t sufficiently capitalized to survive a 1.4 percent rise in unemployment?  If you’re Wells Fargo and Morgan Stanley, well, you use that encouraging news to raise $7.5 billion each today:

In the capital-raising exercises, Wells Fargo sold $7.5 billion of common stock; regulators had ruled it needs to fill a capital hole of $13.7 billion.

Morgan Stanley raised $8 billion by selling $4 billion in common stock and $4 billion in bonds. It increased the total amount it raised compared with its initial plans by $3 billion because of strong investor demand, it said. Regulators had declared that the investment bank needed to raise money to fill a $1.8 billion hole.

Here’s my question — who bought those public offerings?  Friends of Bernie Madoff?  The Morgan Stanley results show that 45% of their expected loan losses are in Commercial Real Estate Loans, a category in which we aren’t even close to the bottom of the market — but their overall.  They did, however, manage to raise $6.5 billion last quarter, and their overall exposure to bad parts of the market is much slimmer than most.

But how bad did people think this was going to be that the news that Wells Fargo’s adverse-case-scenario losses will be $89.6 billion made Wall Street happy?  Shares were up 3.4 today (13.8 percent) on the news.  What?

I’m glad that there’s private capital to be found to shore up these banks, because it does mean that less government money will be needed.  But the sheer, amazing balls of these guys, to use a report of “it’s not as bad as we thought!” to raise billions of dollars — it certainly reminds us that nothing’s really changed on Wall Street in terms of risky behavior.

New York Fed Chair Stephen Friedman Resigns: About Time

The chairman of the board of the Federal Reserve of New York, Stephen Friedman, resigned today — a resignation doubtlessly timed to coincide with the much bigger news of the day, the release of the stress test results.  (I’ll get back to those in a bit).  Though he had earlier announced his intention to resign at the end of the year, he moved the date up as criticisms of his overlapping role at the Fed and on the board of Goldman Sachs have mounted.

The Wall Street Journal ran an A-1 story this week that started thus:

The Federal Reserve Bank of New York shaped Washington’s response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed’s chairman, Stephen Friedman, sat on Goldman’s board and had a large holding in Goldman stock, which because of Goldman’s new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They’ve since risen $1.7 million in value.

Mr. Friedman also was overseeing the search for a new president of the New York Fed, an officer who has a critical role in setting monetary policy at the Federal Reserve. The choice was a former Goldman executive.

The WSJ has been putting up new pieces every day as criticism of Friedman’s moves has mounted.  He’s not a bad target.  He’s purchased more than 50,000 new shares in Goldman since the bank came under Fed regulation last fall, and never mentioned any of those purchases to the NYFed.  His claims that he saw “no conflict whatsoever in owning shares” is at best self-deluding and more likely disingenuous.  Whether or not Friedman was involved in day-to-day decision making at the Fed — and his spear-heading of the search for a new president certainly makes him seem very involved — as a Class C director, appointed to represent the public, holding shares in any bank or bank holding company seems like a dangerous contradiction.

Now, it’s true that Friedman wasn’t initially in conflict with Fed policy — only when Goldman became a bank-holding company, instead of an investment bank, did he come into explicit conflict with the rules, and at that point the NYFed lawyers sought a waiver.  In January, they concluded he hadn’t broken any internal rules — and even in the statement released by the NYFed, the general counsel says “these purchases did not violate any Federal Reserve statute, rule or policy.”

Which makes it seem all the more important that those statutes, rules, and policies get changed. 

Though Friedman showed some terrible judgment here, the other villain of this story is whoever in the Washington, D.C. Fed offices decided to grant the waiver that allowed Friedman to continue in his conflicting role.  The defense that the NYFed has mustered so far for keeping Friedman around is that his leadership was necessary because the NYFed was already functioning without a president, after Tim Geithner became the Treasury nominee in November.  If that was true — if Friedman was so valuable to the company — then the company should have worked harder to convince Friedman to sell of his shares and resign from Goldman.  Instead, they chose to grant a waiver to a rule that, really, is a pretty reasonable rule, one that’s built to arm against exactly the kinds of conflicted decisions that seem to have been made here.

The WSJ reports that many of the other 11 regional Fed banks already have or are supportive of changing and clarifying the rules.  I hope that’s true.  Until then, it falls upon the Wall Street Journals of the world to find this stuff out and push for change — and we may be destined to see the resolution of the problem coming, as it did in this case, too late.