Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.
When you or I take a stress test on the treadmill, the results of this “annual physical” routine are between you and me and our cardiologist. But if we need open heart surgery and a quadruple bypass, sooner or later somebody is going to know that we’re not fit for the annual corporate challenge race. This is the dilemma some are now raising about the Fed’s “stress test” for the 19 largest financial institutions in the US.
While Federal officials have been at pains to point out that it’s not a “pass-fail” exam, still the intention is to give those banks that need more capital to handle the projected “stress” six months to find it and if not, then force them to take Federal money — all to accomplish the goal of not allowing any of these institutions to fail.
Some commentators believe that some of these institutions should indeed be allowed to fail, so for them the idea of disclosing stress test results should make elemental sense; the test will separate those out who might wind up like, say, Lehman or Bear Stearns, without additional capital, and the market will react accordingly, trash their stock, pull their credit, and low and behold, they will fail.
But Congress has yet to enact the new legislation to provide for an “orderly windup” of one of these gigantic holding companies , which do not fit within the existing FDIC “takeover and close down” structure: thus the Government is opting to provide for those at the bottom of the stress test pile with a six month grace period to put their balance sheets right by raising more equity capital.
But how in the world can they raise capital once the capital markets know how low they rank on the stress test? Lehman and Bear couldn’t raise capital when their problems were only rumors; what will happen to institutions where the rumors are confirmed by the US Government? They probably will not be able to raise even their usual overnight operating funding, much less additional equity capital.
It would seem that the Government then will have no choice but to come up with the additional capital itself — right now, not six months from now — since it has no “orderly wind-up” tools in place as yet, and it has committed not to let these institutions fail and not to ‘nationalize’ them either. But it only has between $100 and $140 billion (depending on who estimates it) in TARP money at its disposal, which may not be nearly enough (consider that Citigroup already has $50 billion, which it is not about to return to Uncle Sam any time soon).
Something is missing from this picture. The issue cannot be resolved by keeping the stress tests results secret, now that the cat is out of the bag. Could it be that the stress test scenario will become a stalking horse for some “forced marriages” in the financial sector? Is it the case that the Chrysler-FIAT negotiations going on this week and next are the forerunner of what will come to pass after we know which financial institutions need some sort of “bypass” surgery? And if so, do the merged entities become yet another version of “too big to fail”?
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