Bank Stress Tests Much Ado about Nothing

By: Brewer Futures Group | Fri, May 8, 2009
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In late breaking news, the U.S. Dollar is trading weaker against all major currencies after the Fed's bank stress test results showed none of the 19 U.S. banks being examined is facing insolvency.

If anything was revealed, it was that more than a few of the biggest banks need to raise more capital to meet the Fed's requirements. This can only be accomplished three ways: by selling assets, converting preferred shares to common stock or asking the government for more money.

From an investor's standpoint there is relief that this stressful (no pun intended) period of economic history is over. This may mean that trader appetite for risk is likely to increase as the worst of the banking crisis may be behind us.

Now that the world knows the financial condition of the U.S. banking system, the U.S. Dollar could get trashed as traders seek higher returns elsewhere. Remember all the money that flowed into the Dollar for safety reasons? Well you can pretty much kiss it good-bye.

The question that should be raised is what was accomplished by this whole process? In my opinion it was all done to prop up the value of bank stocks because the Fed was running out of TARP money. Way back in February when the stock market was falling apart because of the lack of confidence in Treasury Secretary Geithner and some bank stocks were headed toward zero, the government had to do something so they announced the stress test program.

Basically it was saying to investors, "You have nothing to worry about until you see the actual numbers. So lay off the bank stocks." Speculative traders naturally began buying the cheapest stocks like Bank of America and Citigroup. Lo and behold it turns out that these are two of the stocks that need capital. I guess the market did get it right by driving their stock prices so low.

If financial stocks did not rally then these stocks would have needed even more capital. Furthermore, we were led to believe that the bank capitalization problem was a major problem. If this is the case then why are we giving the undercapitalized banks until June 9th to come up with a plan to raise capital and until November 8th to actually raise the money? My guess is that the regulators believe that by instilling confidence back in the banking system that investors will drive the bank stocks so high that they may not even need to raise capital by November.

There is only about a $100 billion of TARP money left, but believe it or not the 19 major banks are undercapitalized by only $75 billion. How convenient. What we have really discovered is that if the stock market does not continue to rally and boost the price of bank stocks then the problems of the past could repeat themselves in the future.



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