Banks clash with Fed over release of stress test details

In yet another example of Wall Street's Opacity Protection Team in action, the Wall Street Journal ran an article on how banks are lobbying the Fed not to release the details of the current round of stress tests.

As regular readers know, the results and details of the stress tests themselves are meaningless.

The reason they are meaningless is that since the adoption of regulatory forbearance and the end of mark-to-market accounting at the start of the financial crisis bank financial statements and individual items on them like book capital have been a fiction.

Despite the simple fact that the stress tests and financial statements are meaningless, Wall Street has to fight against anything that might threaten to lift the veil of opacity even a little bit.

After all, the Fed might release some out of date exposure data and analysts would run with this data and rediscover just how much risk these banks are carrying and how insolvent they really are.

Some very large banks are clashing with the Federal Reserve over how much detail the central bank will reveal about them when it releases the results of its latest stress test. 

The 19 biggest U.S. banks in January submitted reams of data in response to regulators' questions, outlining how they would perform in a severe downturn. Now, citing competitive concerns, bankers are pressing the Fed to limit its release of information—expected as early as next week—to what was published after the first test of big banks in 2009. 

Three years ago, as the financial crisis was abating, the Fed published potential loan losses and how much capital each institution would need to raise to absorb them. This time around, the Fed has pledged to release a wider array of information, including annual revenue and net income under a so-called stress scenario in which the economy would contract and unemployment would rise sharply.

Talk about completely meaningless data.

The stress test from three years ago produced results that said this is what happens when there is regulatory forbearance and banks are never required to address the bad loans on their balance sheet.  The significant information released with these stress tests was that US Treasury Secretary Tim Geithner reaffirmed that the US government stood behind the banks and offered a blanket guarantee for depositors, debt holders and share holders.

The Clearing House Association, a lobbying group owned by units of companies such as J.P. Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co., warned in a letter this month to the Fed that making the additional information public "could have unanticipated and potentially unwarranted and negative consequences to covered companies and U.S. financial markets."

Making additional information public could also have unanticipated and positive consequences.

Government officials aren't backing down from their plan to publish detailed projections of how the biggest lenders would fare in a steep economic downturn lasting two years. 

Regulators view full disclosure as critical to assuaging investor concerns about banks' capacity to withstand a market shock or economic setback. 

"The disclosure of stress-test results allows investors and other counterparties to better understand the profiles of each institution," Fed Governor Daniel Tarullo, the central bank's lead official on supervisory matters, said in a speech last November....

Apparently the regulators agree with your humble blogger that full disclosure is critical to restoring confidence.

Where there is a vast gap is the definition of full disclosure.

Your humble blogger thinks in terms of ultra transparency where banks provide on an ongoing basis their current asset, liability and off-balace sheet exposure details.  With this data, market participants can run their own stress tests as part of assessing the risk of each bank.  It is the ability to independently assess the data that restores confidence.

The Fed thinks in terms of disclosing the results and not the underlying data.

Regular readers know that there are several reasons that thinking in terms of disclosing results is flawed:

• It substitutes the Fed's analytical ability for the market's.  Are the 100+ economists at the Fed who did not see and prevent the financial crisis from occurring in the first place really better than the market at analyzing the data?

• It tries to make the market's assessment of the risk of each bank reliant on the Fed for properly performing the stress tests.  A reliance that we know is misplaced because the starting point for the stress tests is the banks' fictional financial statements.  Given that the results of the test are meaningless, it is hard to see how trying to make meaningless tests a significant factor in market participants' assessment of risk is a positive. 

• It morally commits the US government to stand behind and guarantee all depositors, bond holders and equity investors in the stress tested banks.  It is hard not to bailout the bond holders and equity investors after saying that the banks are solvent!

Finally, regular readers know that the stress tests are simply an exercise by the Fed in reminding the market that it has an information monopoly on all the useful, relevant bank information and that it reserves the right to gamble with financial stability.

Fed officials are assuring banks they won't release data that rivals could mine for clues to future acquisitions or other moves. In one concession, the Fed told banks it doesn't intend to break out projected losses on a quarterly basis....

An assurance that guarantees no useful, relevant data will be disclosed to market participants.

The biggest U.S. lenders have been raising capital over the past year, and most institutions are expected to receive approval for dividend increases or share buybacks. Bankers believe those moves will boost their appeal with investors at a time when many financial stocks are trading below book value, a measure of net worth.

The reason that these banks trade below book value is the lack of disclosure.  As the Bank of England's Andrew Haldane observed, banks are 'black boxes'.

Given regulatory forbearance and lack of mark-to-market, there is no reason for market participants not to believe that all of the big banks are insolvent --- the market value of their assets is less than the book value of their liabilities -- and hence, just like the opaque, toxic subprime mortgage backed securities, investors are only willing to gamble that a fraction of book value is what the banks are worth.

This believe is confirmed every time that Wall Street's Opacity Protection Team springs into action to object to disclosure.

After all, if there were nothing to hide, then banks would be willing to disclose!!!

Keep in mind that throughout history, the sign of a bank that could stand on its own two feet was a bank that disclosed all of its current asset, liability and off-balance sheet exposure details.

Even so, regulators are walking a fine line with the latest test. If banks look ill-equipped, markets could be spooked, adding to the stress on firms already struggling with the low interest rates, soft growth and new rules that led banking-industry revenue to fall last year for just the second time in 74 years. 

Shares of the biggest banks fell as much as 58% in 2011 amid questions about the industry's profit outlook and the impact of the European debt crisis. 

If regulators are viewed as too pliant, the tests will fall short of their basic confidence-building purpose, possibly undermining a market recovery that pushed the Dow Jones Industrial Average above 13000 for the first time in four years and pushed the KBW index of commercial bank stocks up 16%. 

Similar tests administered by regulators in the European Union were denounced for giving passing grades to some lenders that later required taxpayer bailouts.

This perceived need to walk a fine line is another reason that your humble blogger says that the Fed should run its stress tests as mandated by Dodd-Frank and never leak a word about them.

For example, everyone knows that the Fed is going to let the grossly undercapitalized banking industry pay dividends and increase the exposure of the taxpayer to the losses hidden on and off the banks' balance sheets.

The Fed should quit being offensive and publicly tying the results of the stress tests to permitting dividends to be paid.

Soon after the Fed said last November that the results would be made public, the debate began about how much the Fed should disclose. 

More than a dozen bank holding companies subject to the stress tests—all with at least $50 billion in assets—met with Federal Reserve staff in late December to discuss what the Fed might say, according to disclosures on the Fed's website. 

The meetings were at the Fed's invitation, and Fed staff said they were still considering the timing, scope and level of detail of the data they will publish, according to a summary of the meetings posted by the Fed. 

Officials from Metlife Inc., Bank of America, J.P. Morgan Chase, Goldman Sachs Group Inc. and other financial institutions also discussed with Fed staff the implications, including competitive issues, of making the results public.  

Bankers say it is unfair for the Fed to release more information than it did during the initial 2009 stress tests. 

The reason: The Fed is still in the middle of writing a rule establishing what information it will make public in future stress tests, as required by the Dodd-Frank financial law passed in 2010.

The only thing the Fed should say is that it conducted stress tests.

Last year the Fed didn't make any aspect of its stress test public, leaving disclosure to institutions, many of which then released some results. Some bankers warn they may put out their own figures if they disagree with the Fed's calculations. 

"They could just publish something that has nothing to do with reality," said one top executive at a major bank.

Absolute true as anything that the Fed says about the stress tests has absolutely nothing to do with reality since the tests themselves have absolutely nothing to do with reality!