23 February 2009

As Doubts Grow, U.S. Will Judge Banks’ Stability

This article is extracted from the 23 February 2009 edition of “The New York Times”.

The Obama administration will begin taking a hard look at the financial condition of the country’s 20 biggest banks this week to judge whether they could hold up even if the downturn worsens further than policy makers already expect.

These reviews of the banks’ books, known as “stress tests,” are heightening a dilemma for Obama aides about how candid they should be about the health of banks like Citigroup and Bank of America. The tests are expected to take several weeks.

Bank shares were pummeled last week, partly because of rumors that the government might nationalize some of the banks. Officials consider many of the top 20 banks “too big to fail.”

The tests come as anxiety is building among investors and industry analysts about the Treasury Department’s broader plan to shore up the banking system. People familiar with the plan, which has been criticized by executives and analysts as vague, say its crucial details may not be ready for another few weeks.

In yet another sign of distress for the banks, Citigroup officials were in active talks with federal regulators on Sunday night about plans for the government to take a bigger ownership stake in the bank, according to a person close to the talks.

Citigroup approached the regulators with a plan that would allow them to convert a large amount of the government’s $45 billion of preferred shares, which is treated as debt, into common stock, this person said. The government owns a stake of roughly 8 percent, but that could grow to as much as 40 percent. …

Still, the big banks say they remain relatively healthy and that, with time and support from the government, they will regain their footing. But many economists, Wall Street analysts and even some bank executives contend that some of the banks are already effectively insolvent. …

This camp says it would be best to nationalize some of them now — with the government wiping out shareholders and taking over the operation of some institutions, at least temporarily — rather than to drag out the process while the economy spirals further downward.

The stress tests will use computer-run “what if” situations to estimate what would happen to each bank under Depression-like conditions, with unemployment surging to 10 or 12 percent, for example, or home prices dropping 20 percent further, Treasury and Federal Reserve officials said.
Fed officials emphasized that these hypothetical events were “highly unlikely” to occur….

…But because the tests involve nightmarish economic conditions, the results of the tests are
likely to strengthen the case that some of the major banks need more capital. That would increase the likelihood that the government would increase its stake and dilute or even wipe out the shares held by private investors. …

Bank executives reached over the weekend said that the tests might not produce information that is very different from what regulators already know about the banks. The Federal Reserve already has hundreds of examiners on site at the largest banks, monitoring their businesses.

Meanwhile, the revelation that details of the Treasury’s new bank rescue plan might not come for several weeks leaves banks and their shareholders to stew….

But on Friday, and for much of last week, investors acted as if they were betting on government takeovers and dumping bank shares in response. Shares in Citigroup, for example, fell 44 percent, and Bank of America stock dropped 32 percent….