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Banks Pass Stress Test - Regulators Fail Ethics Test



May 11, 2009 – Comments (4)

Another article, this one over at Hussman Funds, pointing out the practical and ethical problems of continued government intervention in the banking sector.  Here are some excerpts:

As an example, Citigroup comes in with $119 billion in capital ($22 billion as Tier-1 common). Total assets are over $2.1 trillion, but the stress test assumes “risk weighted” assets of less than half that. Citi projects losses in 2009 and 2010 of $104.7 billion in a scenario where the unemployment rate reaches 10.3%. Citi assumes that it will earn $49 billion during that period which would partially absorb those losses, and that it will obtain $87 billion in Tier-1 from other capital sources, presumably including $33 billion of preferred that it would be willing to convert to common. Of course, Citi's entire market cap is only $22 billion, so the “$5.5 billion” that Citi is reported to need under the stress test is what it would require after a 5-to-1 dilution in its common stock (87+22/22). Essentially, we've got a company with a common equity buffer of just over 1% of total assets, that just 8 weeks ago was on the verge of receivership, and investors are urged to believe that there are enough voodoo dolls in the vault to make the company solvent even in a further weakened economy......

Over the past few weeks, I've heard a number of analysts suggesting that the bailouts aren't so bad because “we owe this money to ourselves,” and that in terms of present value, they are neutral for society as a whole. What's fascinating about these arguments is that they entirely miss the ethical and distributional effects of the bailouts. This isn't something that would be missed if the Treasury was to borrow a trillion dollars and then hand it over to a fur-coated pimp standing on a street corner in lower Manhattan, but it somehow escapes concern when the recipients are in the offices above the ground floor. It's amazing how quickly capitalists turn into socialists when they stand to lose money.....

Notice that by bailing out the financial companies, there is a massive crowding out of private investment, because for every dollar of losses that should have been wiped off the ledger, we are forced to retain and service two dollars of overall debt – the debt securities owed by the financial companies to their bondholders continue to exist, and we now have an equal amount of new debt issued by the Treasury. The rescued bank debt is a drain on the public because it has to be serviced through a combination of higher interest rates to borrowers, and lower deposit rates to savers. Meanwhile, the Treasury debt is also a drain, because except for some income from the Treasury's holdings of preferred stock, the debt has to be serviced from tax receipts....


Ethical arguments? This guy is wasting his time. No one who makes ethical arguments gets far in banking or politics.  If we wanted to make ethical arguments, there would be no Federal Reserve, no monopolies, cartels, taxation......  But I digress.

David in Qatar

4 Comments – Post Your Own

#1) On May 11, 2009 at 11:24 AM, alstry (35.03) wrote:

It gets tiring doesn't it?????

Evil triumphs when the good do nothing.

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#2) On May 11, 2009 at 11:34 AM, binve (< 20) wrote:

Good post man, I agree with your ending paragraph. Thanks.

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#3) On May 11, 2009 at 12:30 PM, rd80 (98.66) wrote:

The risk weighted asset number for Citi may be correct.  Recall they got a gov't backstop on $306 billion of assets by issuing $7 billion of preferred to Treasury and the Fed back in Nov. 

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#4) On May 12, 2009 at 2:10 PM, nzsvz9 (< 20) wrote:


I'm quite surprised that the writer even treads into the unethical nature of what was done at all. And the fur-coated pimp in the Wall Street dark alley is just priceless. What an image!

Sure, he's performing a quantitative analysis (probably his job - so don't fail him there) based on a false premise overall, but the numbers are what they are. At least he qualifies them with the socialism comment.

Sure, it's flawed, but much better than most I've seen.

Known by my ethics professor as student nzsvz9

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