What would your finances look like if nationwide unemployment rose to 10.3 percent? How about if average real estate values in the United States fall another 22 percent?
You may have trouble coming up with an answer. The unemployment rate might not affect you at all; on the other hand, you might end up unemployed. You might live in a relatively bust-resistant neighborhood, or your house value might fall even faster than the average.
These are among the questions the country's 19 largest banks have been subjected to [pdf] (for what feels like years but is actually just since February) under the Federal Reserve's "stress test" or "SCAP." The Fed, the Department of the Treasury, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, after weeks of strife and foment, released the results of the stress test [pdf] last night. If you had trouble answering the above questions about yourself, you can understand why banks had such a hard time with the stress test.
That is, the problem with the stress test is the same limitation on any kind of standardized test. By trying to map a diverse collection of institutions, many of them regional banks whose dynamics differ widely from those of international banks, the stress test produced a range of interesting yet inconclusive statistics. "The idea of using some level of unemployment to say whether Citigroup is not as strong as JP Morgan to me is laughable," longtime investor Mike Holland told MSNBC recently.
This is not to second-guess Treasury Secretary Tim Geithner. As bully pulpit exercises go, the stress test was one of the more necessary, and certainly the most justifiable. The Department of the Treasury is on the hook for hundreds of millions of dollars—hemmed in, ironically, by the free-handed methods of Geithner's predecessor Henry Paulson, who in 2008 successfully lobbied spooked congresspersons and an unprincipled president into approving more than a trillion dollars in support for financial institutions. Promises made last year, and subsequent promises made this year, have effectively told all players at the table that the government will stay in the game until the sucker has been identified.
In this context, it's difficult for an honest person to condemn the government's doing a census of the market. The stress test was both reasonable and reasonably applied. That's why it demonstrates, even better than a screwup would have, the grotesquery of government action.
Predictions of the stress test results have been widely distributed ahead of the actual release. The final score tracks so closely to the preliminary spread that it's evident the government has been very carefully managing expectations. As a result, a new stupid-like-a-fox reputation has descended upon Geithner.
That reputation may be deserved. With all due respect to conspiracy theories about market makers, large buyers and sellers try very hard not to make the market. This was—or was claimed to be—the great challenge facing Fidelity Magellan Fund managers back in Magellan's heyday: how to get into or out of a large position in a given security as quickly and as quietly as possible, before the market reacted?
Geithner faced the same challenge, but with none of the silence, exile, or cunning available to a fund manager. All the major public and private players in the stress test would have preferred to keep the entire exercise a secret (speaking of which, why wasn't the Air Force involved?), and it took considerable wrangling just to get a partial disclosure of the results. In the end, even Geithner could not cancel centuries of law and consensus regarding secrecy in public spending. So he took pains to make sure the results would be absorbed ahead of time.
It's tempting to say the Obama administration has played its unlucky hand superbly. (And since I'm told we're all in this together, let's throw Federal Reserve Chairman Ben Bernanke in with the administration.)
But a closer look at how bank stocks fared in the market this week makes that harder to believe. To take two examples, Bank of America (BoA), which was predicted to be undercapitalized by a cool $34 billion, surged ahead of the stress test results. The final tally was off by only $100,000,000, with BoA's "SCAP buffer" coming in at $33.9 billion. But Wells Fargo, which was expected to be light by only $15 billion and may be better positioned to survive, saw its stock pummeled. And Wells Fargo's SCAP buffer turned out to be more than a billion dollars lower than predicted, at $13.7 billion. Results like these must be why Wells Fargo chairman Dick Kovacevich swaggers like a eunuch, raging against the conditions attached to the money he chose to take.
However, this week generated another piece of evidence of the administration's skill: the trial balloon proposal to allow banks to pay back their Troubled Asset Relief Program funds—subject, of course, to means testing. Coming back to back with the government's inanely sunny comments about the stress test, this suggests that President Obama may be telling the truth when he says he'd like to have less on his plate: The Democrats recognize that bailouts are a political loser. They want out of the bank business.
This desire, though, gives rise to some inflated hopes. The Democrats are still sure that the good old American machine will start producing again one of these days. They seem to think that having ended this particular Bush intervention, they will share in the bounty of the free market, without having to pay it any respect. Some economists believe the Democrats are supported in that hope. Others do not. Bernanke splits the difference.
But there's a moral reason to hope that the Democrats won't be able to exit the economic quagmire. It offends the conscience to consider that Citigroup, Wells Fargo, or Bank of America may survive. It is insulting to think that they may not only survive but be allowed to withdraw back into the private sector after the downturn is over, that in a few years their CEOs will again be the de facto spokespeople for the free market.
This is why I propose that the Treasury immediately seize all four institutions that scored a bigger-than-five-billion-dollar SCAP buffer. That would be: Bank of America, Wells Fargo (my bank at this time for all lending and borrowing), Citigroup, and GMAC (or wait, has that last one already happened?).
The Treasury should seize all four of these institutions, formally and immediately. This would be a form of blight removal during a period when the credit markets are clearly overbuilt. In this way, the market can teach Ho Chi Minh's lesson to a new generation of Democrats.
Contributing Editor Tim Cavanaugh writes from Los Angeles.