The end of the beginning for the losses of the American banking system? The stress of waiting for the stress tests

Călin Rechea

The American financial market is experiencing the emotion of the financial reports for the first quarter of 2009. All eyes are locked on the large banks, which are trying not to disappoint anyone. Wells Fargo, Goldman Sachs and JP Morgan have helped maintain the optimism of the markets.

Then it was Citigroup"s turn. According to one set of accounting regulations, the bank had USD 1.6 billion in profit. According to the classic accounting rules, that have themselves a significant dose of fantasy, the profit in question was actually a loss of almost USD 1 billion. It"s only because the value of Citi"s bonds dropped that the bank managed to post an illusory USD 2.5 billion profit. Investor"s distrust of Citi"s reported earnings caused the shares to close 9% lower on at the end of Friday"s NYSE trading session.

The low relevance of positive results, caused by the modification of some reporting requirements, are causing tension in the market to grow, while waiting for the conclusions of the stress tests in the banking system. The government is still reviewing the method for publishing the results of the stress test for the 19 largest banks in the United States.

Professor Nouriel Roubini is one of those who aren"t fretting over the conclusions of the authorities. "The results of the stress tests - even before they are published - aren"t even worth the paper they are written on"", he says on the website of his company, Roubini Global Economics. What is the basis of his verdict? Several macroeconomic indicators - economic growth, the unemployment rate and the average decrease of home prices - have already exceeded the most pessimistic hypotheses of the stress tests (see table).

Joseph Stiglitz, 2001 Nobel prize winning economist and former chief-economist of the World Bank, considers that the efforts of the Obama administration to save the banking system are doomed to fail for other reasons as well. In a statement made for Bloomberg, professor Stiglitz says that the government"s plan was created to save Wall Street and not to create a viable financial system. "Those who initiated the plans are either in the bankers" back pocket or they are incompetent", Stiglitz said.

Professor Willem Buiter, of London School of Economics, is not impressed by a possible good outcome of the stress test of the American banking system. Besides the fact that the economic decline has far exceeded the most optimistic scenario of the authorities in Washington, Buiter also reminds us that the test only focuses on 40% of the banking assets. The remaining 60%, made up of conventional loans, will be affected in the coming months, as a result of the severe contraction of the American economy. What is Willem Buiter"s solution? Supplementing the toxic asset buyout program by another 1.5 trillion dollars, of which 500 billion would be used to recapitalize the banks. The odds of Congress voting for this "solution"? Zero, according to the professor"s blog on the Financial Times website.

Even without this increase of the US public debt by USD 1.5 trillion, the former head of the US Government Accountability Office, David Walker, is concerned about the increase of said public debt, as a result of the programs for the rescue of the financial system. "Regardless of the statements of politicians, the accumulation of debt, which is not accompanied by a dramatic downsizing of the size and role of the government, can only mean a delayed increase of taxation", he said, according to an article posted by CNN. Needless to say how "beneficial" increasing taxes what an increase of taxes would be for any positive trends of the economy?

Under these circumstances, it"s no wonder that the authorities are permanently trying to change the definition of transparency, when talking about publishing information about the programs for supporting the financial sector.

What was it the current American president promised during his electoral campaign? "Change we can believe in", which is also the title of a book by Barack Obama. His slogan was initially "Yes, we can", but it eventually changed into "No, you can"t and don"t need to know", at least according to what Bloomberg LP experienced. Based on the Freedom of Information Act, the former has been trying to get details on the USD 2 trillion loan to granted by the Federal Reserve to the financial institutions. Bloomberg considers that citizens should be aware of the risks of these loans, because the public has become an "involuntary investor" in the great Wall Street banks. Several members of the Congress have asked for increased transparency, but in vain. Meanwhile, the Federal Reserve extended its program for the acquisition of government bonds to also include TIPS (Treasury Inflation Protected Securities). The principal of these bonds is inflation indexed, and their evolution is considered as a strong signal of inflationist expectations. Standard 10-year and 30-year notes year maturity, have also seen their yields increase again, bringing them close to their levels prior to the beginning of the quantitative relaxation.

The market for government of American government bonds show that the Fed is being subjected to increasing pressure as a direct result of its actions. The more it buys bonds to lower their yield, the more investors worry about inflation, which leads to an increase of the demanded yields. How will the American Central Bank break this vicious cycle?

Even the balance sheet of the Federal Reserve will soon need a stress test, and the forecasts are not looking good for the Obama administration