Bear Stearns Trash Still in the FED Roach Motel (Graph)

On June 26, 2008, the Federal Reserve Bank of New York (FRBNY) extended credit to Maiden Lane LLC under the authority of section 13(3) of the Federal Reserve Act. This limited liability company was formed to acquire certain assets of Bear Stearns and to manage those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets.

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Original content Bob DeMarco, All American Investor

Reserve Bank Credit (Graph) - Securities Held Outright - Federal Agency Debt Securities

Up, Up, and Away.



Note: The current face value of federal agency obligations held by Federal Reserve Banks. These securities are direct obligations of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

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St. Louis Source Monetary Base (Graph)

Wonder why gold is trading up? Here is one good reason.

• Sum of currency in circulation, 
• Reserve balances with Federal Reserve Banks, 
• and service-related adjustments to compensate for float.

Calculated by the Federal Reserve Bank of St. Louis.

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Reserve Bank Credit Remains Stubbornly High (Graph)

This is the truest measure of Fed liquidity. While Reserve Bank credit has peaked it still remains high and well above trend. This series needs to be watched closely. It is likely that the market will experience a sharp correction when the Fed starts to take out this over abundance of liquidity.

Is the market strong, or is what we are seeing being caused by this aggressive liquidity injection on the part of the Fed. In other words, are we seeing a real case of excessive exuberance?

Reserve Bank credit is the sum of securities held outright, repurchase agreements, term auction credit, other loans, net portfolio holdings of Commercial Paper Funding Facility LLC, net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility, net portfolio holdings of Maiden Lane LLC, net portfolio holdings of Maiden Lane II LLC, net portfolio holdings of Maiden Lane III LLC, float, central bank liquidity swaps, and other Federal Reserve assets.

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Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 700 articles with more than 18,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments.

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Reserve Bank Credit Dropping are Higher Interest Rates Ahead (Graph)

Reserve Bank Credit is peaking. Reserve credit is down from the peak of $2,236 billions during December, 2008, the secondary top at $2,165 billions during May, 2009. The current reading is $2,010 billions.

This series should be watched closely. The current drop in the dollar could force the Federal Reserve to continue draining reserves from the system to protect the dollar from an all out free fall.

This will likely lead to an increase in long term interest rates. However, it is time to start watching the two year treasury security closely.



Note: Reserve Bank credit is the sum of securities held outright, repurchase agreements, term auction credit, other loans, net portfolio holdings of Commercial Paper Funding Facility LLC, net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility, net portfolio holdings of Maiden Lane LLC, net portfolio holdings of Maiden Lane II LLC, net portfolio holdings of Maiden Lane III LLC, float, central bank liquidity swaps, and other Federal Reserve assets.

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FED Bank Reserve Credit (Graph)

Reserve Bank credit is the sum of securities held outright, repurchase agreements, term auction credit, other loans, net portfolio holdings of Commercial Paper Funding Facility LLC, net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility, net portfolio holdings of Maiden Lane LLC, net portfolio holdings of Maiden Lane II LLC, net portfolio holdings of Maiden Lane III LLC, float, central bank liquidity swaps, and other Federal Reserve assets.

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More from All American Investor

• Bond Vigilantes Take over in the Long End (Graph)
• Ten Year Treasury Yield in Orbit (Graph)
• Ten Year Interest Rates Rising (Chart)
  
• Option ARM--The Toxic Mortgage
• Systemic Risk Defined--Too Big to Fail
• Ray Dalio on the current state of affairs in the market
• Roubini Predicts U.S. Losses May Reach $3.6 Trillion
• 60 Minutes -- Cold Fusion

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Reserve Bank Credit Soaring Again (Graph)

Reserve Bank Credit, Factors Affecting Reserve Balances

The Federal Reserve is starting to expand their balance sheet again. Week over Week.

• The biggest increase this week is in the purchase of Mortgage Backed Securities (MBS) -- up $75 Billion. 
• An additional $18 Billion increase in Maiden Lane LLC (Bear Stearns bailout).
  
• An additional $ 34 Billion increase in Maiden Lane II LLC and Maiden Lane III LLC (AIG bailout).
• U.S. Treasury securities held outright rose $94 Billion, and $405 Billion versus a year ago.
  
• Reserve Bank Credit rose $70 Billion week, and $1.3 Trillion versus a year ago.
• Reserve Bank Credit now stands at $2.169 Trillion and is once again approaching the peak of $2.31 Trillion (December, 2008).
  

Notes: H.4.1 Reserve Bank credit is the sum of securities held outright, repurchase agreements, term auction credit, other loans, net portfolio holdings of Commercial Paper Funding Facility LLC, net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility, net portfolio holdings of Maiden Lane LLC, net portfolio holdings of Maiden Lane II LLC, net portfolio holdings of Maiden Lane III LLC, float, central bank liquidity swaps, and other Federal Reserve assets

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Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments.

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PIMCOs Mohamed El-Erian on the Bank Stress Test

The article was written by PIMCO's Mohamed El-Erian.

The stress tests will accelerate the redefinition of the financial landscape, with a meaningful impact on future economic growth and welfare. However, whether the impact is for good or ill depends on how the results of the tests, and policies that flow from them, are pursued.

He makes the following key points:

• The report must be transparent. He points out that the results will be examine by analyst all over the world. As a result, the methodology, assumptions, and analysis needs to clear and easily understood.
• The results should be forward looking. The report should explain how the good banks get out from under the government. And, how bad banks that do not have access to private capital will be handled.

There can be little doubt that the release of the bank stress test information needs to be clear, concise, and understandable.

This is essential to create confidence in the market place. If the bull market in stocks is to continue, the report must create a sense of confidence. Anything less is likely to send the market back for a test of the lows we saw in early March.

This is a well written article that should be read and considered.

Bank tests we should get stressed about

Bank Stress Test Leaked?

The so called Turner Radio Network claims they have the results of the bank stress tests. To be honest, I am not really familiar with TRN. Here is a snip of what they are reporting.

1) Of the top nineteen (19) banks in the nation, sixteen (16) are already technically insolvent.

2) Of the 16 banks that are already technically insolvent, not even one can withstand any disruption of cash flow at all or any further deterioration in non-paying loans.

3) If any two of the 16 insolvent banks go under, they will totally wipe out all remaining FDIC insurance funding.

4) Of the top 19 banks in the nation, the top five (5) largest banks are under capitalized so dangerously, there is serious doubt about their ability to continue as ongoing businesses.

5) Five large U.S. banks have credit exposure related to their derivatives trading that exceeds their capital, with four in particular - JPMorgan Chase, Goldman Sachs, HSBC Bank America and Citibank - taking especially large risks.

6) Bank of America`s total credit exposure to derivatives was 179 percent of its risk-based capital; Citibank`s was 278 percent; JPMorgan Chase`s, 382 percent; and HSBC America`s, 550 percent. It gets even worse: Goldman Sachs began reporting as a commercial bank, revealing an alarming total credit exposure of 1,056 percent, or more than ten times its capital!

7) Not only are there serious questions about whether or not JPMorgan Chase, Goldman Sachs,Citibank, Wells Fargo, Sun Trust Bank, HSBC Bank USA, can continue in business, more than 1,800 regional and smaller institutions are at risk of failure despite government bailouts!

For now I would be cautious about this information. If you would like to check it out, go here.

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Bank Prime Loan Rate -- Current and Long Term Graph

Current 3.25 percent. All Time High, 21.50 Percent, December, 1980. H.15 Selected Interest Rates

Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments.

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Swiss slide into deflation signals the next chapter of this global crisis

"This is something that we must prevent at all costs. The current situation is extraordinarily serious," said Philipp Hildebrand, a governor of the Swiss National Bank.

The SNB is not easily spooked. It is the world's benchmark bank, the keeper of the monetary flame. Yet even the SNB's hard men have thrown away the rule book, taking emergency action to force down the exchange rate of the Swiss franc.

Read the article.

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AIG chiefs pressed to donate to Dodd

As Democrats prepared to take control of Congress after the 2006 elections, a top boss at the insurance giant American International Group Inc. told colleagues that Sen. Christopher J. Dodd was seeking re-election donations and he implored company executives and their spouses to give.

Getty Images Sen. Christopher J. Dodd, chairman of the Senate Banking, Housing and Urban Affairs Committee, has lost some political standing heading into re-election because of his ties to American International Group Inc.

The message in the Nov. 17, 2006, e-mail from Joseph Cassano, AIG Financial Products chief executive, was unmistakable: Mr. Dodd was "next in line" to be chairman of the Senate Banking, Housing and Urban Affairs Committee, which oversees the insurance industry, and he would "have the opportunity to set the committee's agenda on issues critical to the financial services industry.

EXCLUSIVE: AIG chiefs pressed to donate to Dodd

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Stocks Don't Fight the Tape

I first heard Martin Zweig utter these words--Don't Fight the Tape--at speech he gave in New York city. At the time it really caught my attention. A very simple rule that is easy to understand.

When the Federal Reserve lowered bank reserve requirements at the depths of the recession in 1991-1992, Zweig went bullish after being bearish for some time. He astutely understood that the FED action would have a major impact on banks and then the stock market. Stocks began their march up to 10,000 on the Dow shortly thereafter.

When the Treasury announced this week that they would be purchasing $1 Trillion in assets--Treasuries, mortgages, etc.--those words of Zweig immediately came to mind. The immediate reaction to the news was a monster reversal and rally in the stock market. Jim Cramer was at his manic best right after the news. In the next few days as Congress spent hours and hours discussing the AIG bonuses the market sagged. Nothing like obscuring the real issues to get some free face time--the $165 million is a drop in the bucket.

I think the news that the Treasury is going to buy assets, and keep interest rates low for a long time bears close watching. Often it takes more than a few days for news of this magnitude to get into the market.

Frankly, this is a very bullish development. The big question for me is simple. Is this the news that will help the market consolidate, or is this big big news that sends the market sharply higher. My guess is that we are going to have one monster rally shortly. I could envision the market on the S and P 500 soaring up to 900 or 1000. That would qualify as one heck of a rally.

The best approach in my opinion is to buy stocks that will benefit from inflation. An ETF like MOO would benefit from an increase in inflation (note: I own this ETF).

For those of you that are bearish remember these words--Don't Fight the Tape. For those of you that are bullish take heart--a big bear market rally is coming soon.

Investing Strategy

Martin Zweig's basic stock market strategy is to be fully invested in the market when the indications are positive and to sell stocks when indications become negative. Risk minimization and loss limitation are crucial to his strategy. His book Winning on Wall Street describes how he determines whether to be fully invested or not.

Zweig says, "People somehow think you must buy at the bottom and sell at the top to be successful in the market. That's nonsense. The idea is to buy when the probability is greatest that the market is going to advance". Zweig uses fundamental company data to select stocks to buy while the market is positive.

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Money Supply continues to Soar (Chart)

M2, Money Stock continues to soar and accelerate. Chart current through March 20.

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Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now

Trend World Protectionism on the Rise

I think most people believe that trade barriers are a bad thing. World protectionism and trade barriers prolonged the recession and impacted trade negatively in the 1930s.

I have to ask myself--have we really learned anything from the past? Or, are we doomed to repeat the same old mistakes?

Seventeen of the G-20 countries recently implemented 47 measures whose effect is to restrict trade at the expense of other countries. I can just hear the analyst on TV--this is no big deal and it won't have a big impact on trade.

These analyst, are the same analyst that, told us over and over that the housing bubble wouldn't have a big effect on the economy or stocks. Right Larry Kudlow? The same analyst that failed to see the interconnectedness of banks and financial companies--as Bear Stears, Lehman, and AIG went down the tube and brought other companies that did business with them to the brink of disaster.

For some reason, analyst have a problem seeing how things are interconnected. They are either dumb, myopic, or in a state of denial like most the country.

You hear the words global economy over and over. There can be no doubt that the world economy is now interconnected. It should be obvious that if one spoke in this interconnectedness breaks the entire wheel stops working. Think of it like the wheel on a bike--when the spoke breaks the wheels gets all wobbly. If you keep riding on the wheel, it will eventually weaken and then collapse. The lesson from this story is, if you fix the broken spoke immediately--the wheel works just fine. But if you keep riding on the bad wheel--it collapses.

There is, at the minimum, anecdotal evidence that global protectionism is on the rise. What are world leaders and politicians likely to do to satisfy angry constituents when their job is on the line? At first, they will stick a lollipop in the mouth of their constituents. But, if that doesn't work, they will give them what they want to perpetuate themselves in office. This is worrisome.

Over here in the U.S. we are now protecting steel, soon it will be the importation of foreign automobiles, then what? For every action there is likely to be an equal and opposite reaction. These are trends that investors need to be watching. Excessive protectionism could cause the next collapse in stock prices. As an investor you need to keep your eyes and ears open--you really need to pay attention to trends and how they can effect stock prices. Like it says up at the top:

How to make money in the market...think beyond the obvious...spot the trends...and do your homework.

If you would like to read about protectionism go here.

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60 Minutes Your Bank Has Failed What Happens Next?

60 Minutes Gets A Rare Look At How The FDIC Takes Over Banks And Reassures Depositors

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(CBS) As staffers of the Federal Deposit Insurance Corporation enter the Heritage Community Bank on a Friday night - surprising employees with the news they are taking over the failing institution - 60 Minutes cameras and correspondent Scott Pelley are there to report on a process that's happening more and more in a foundering economy.

Pelley's report, including an interview with FDIC chair Sheila Bair, will be broadcast this Sunday, March 8, at 7 p.m. ET/PT.

Bair says 25 U.S. banks failed last year and expects many more this year. "It's going up. There have been 16 already now," she says. 60 Minutes was there for one of the latest ones.

On Friday evening Feb. 27, 60 Minutes recorded the arrival of the FDIC team as they entered Heritage Community Bank in Glenwood, Ill. The employees reacted mostly with shock and dismay. "I would say a large majority of the employees don't know that the bank is in trouble and is about to close until we walk in the door," Arthur Cook, the FDIC supervisor of the Heritage takeover, tells Pelley.

Heritage Community operated for 40 years, had 12,000 deposits totaling more than $200 million and was warned by the FDIC and Illinois state banking regulators more than four months ago that it was in trouble due to bad real estate loans. The FDIC takes total control. "We have accountants, asset specialists who specialize in loans…the physical facilities," says Cheryl Bates, the FDIC’s closing team manager. "We have a group of investigators that come in and do a review on the reasons of the bank failure."

Cook and Bates work for the FDIC's Division of Resolutions and Receivership.

Then they alert the media and the bank opens the next day, in this case under the name of the new owner, MB Financial, which bought the bank in a secret auction. This is one of the ways that the FDIC takes over a bank; in other cases, it may close the bank and pay off depositors or it may choose to run the bank itself.

The next day, the doors open, and as 60 Minutes cameras roll, anxious customers - including one carrying an empty briefcase - came into the bank. Only one withdrew a great deal of her money. The man who intended to close his account left with his valise empty, satisfied that the bank was in good hands. MB Financial is now in control and it's almost as if nothing happened. "Almost nothing did happen," says MB's CEO Mitchell Feiger, there to greet his new customers. "It's the same products, the same services, it's the same people taking care of the same customers."

The cost to the FDIC insurance fund of taking over Heritage and making a deal with MB Financial to buy it could end up costing $41 million and none of that money comes from taxpayers. "It is money from our reserves…and we are funded by insurance premiums that are assessed on banks," says Bair.

Asked why large, troubled banks like Citibank can't be saved by the FDIC and must rely on taxpayer bailouts, Bair explained that the FDIC deals only with federal or state chartered depository institutions.

She would not comment specifically on any bank but said "[these institutions] are really very large financial organizations….it's more than a bank. It's a broker dealer. It's offshore operation. It's foreign deposits," says Bair. Companies like Citigroup are large holding companies, with a variety of assets operating around the world.

She says because of this, there is no equivalent resolutions procedure to what the FDIC currently does that could encompass such an broad-based financial company with so many entities.

But Bair believes Congress should consider whether to let such banks get so large. "I think taxpayers rightfully should ask, that if an institution has become so large that there is no alternative except for the taxpayers to provide support, should we allow so many institutions to exceed that kind of threshold?" she asks.



Produced by Henry Schuster

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Bob DeMarco is a citizen journalist, blogger, and Caregiver. In addition to being an experienced writer he taught at the University of Georgia , was an Associate Director and Limited Partner at Bear Stearns, was CEO of IP Group, and is a mentor. Bob currently resides in Delray Beach, FL where he cares for his mother, Dorothy, who suffers from Alzheimer's disease. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. His content has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments.

More from All American Investor

• Systemic Risk Defined--Too Big to Fail


• Ray Dalio on the current state of affairs in the market


• Roubini Predicts U.S. Losses May Reach $3.6 Trillion


• Six Errors on the Path to the Financial Crisis


• Who Caused the Financial Crisis?


• Option ARM--The Toxic Mortgage


• Debt Binge--The Perfect Financial Storm


• Warren Buffett's Annual Letter to Investors (Cliff Notes Version)

Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now

Plan to Move Distressed Assets Could Move Stocks Higher

Put me down as a fan of this plan. It could end up being a stroke of genius. This definitely trumps the Resolution Trust Corporation (RTC) plan that was used to dispose of the assets from failed Savings and Loans.

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The Obama team announced its intention to partner with the private sector to buy $500 billion to $1 trillion of distressed assets as part of its revamping of the $700 billion bank bailout last month.

...private investment managers would run the funds, deciding which assets to buy and what prices to pay. The government would contribute money from the $700 billion bailout, with additional financing likely coming from the Federal Reserve and by selling government-backed debt. Other investors, such as pension funds, could also participate. To encourage participation, the government would try to minimize risk for private investors, possibly by offering non-recourse loans.

'Bad Bank' Funding Plan Starts to Get Fleshed Out

Bob DeMarco is a citizen journalist, blogger, and Caregiver. In addition to being an experienced writer he taught at the University of Georgia , was an Asociate Director and Limited Partner at Bear Stearns, was CEO of IP Group, and is a mentor. Bob currently resides in Delray Beach, FL where he cares for his mother, Dorothy, who suffers from Alzheimer's disease. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. His content has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, BlogCritics, and a growing list of newspaper websites (15). Bob is actively seeking syndication and writing assignments.

Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now

U.S. to Take Big Citi Stake and Overhaul the Board

Main points:

• We didn't put in any more taxpayer dollars (not yet anyway).
• The deal addresses the issue of the Board of Directors. The Board will be constructed of new, independent members. I wonder why this took so long?
• Chief Executive Vikram Pandit keeps his job.
• If full dilution occurs we the taxpayers end up owning 36 percent of the bank. We are way underwater.
• The deal boost the bank's tangible common equity ratio. Makes the bank look good for now.

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U.S. to Take Big Citi Stake and Overhaul the Board

U.S. to Take Big Citi Stake and Overhaul the Board

By KEVIN KINGSBURY and MAYA JACKSON RANDALL

Struggling banking giant Citigroup Inc., moving aggressively to shore up its equity base, announced a stock swap Friday that if successful will leave the government owning more than a third of the company and wipe out nearly three-quarters of existing shareholders' stake.

The move is an acknowledgment that more than $50 billion in government capital and a backstop on more than $300 billion in troubled Citigroup assets haven't been enough to stop the bank's slide. It also represents a deepening of the government's role in trying to prop up the U.S. banking sector.

Under the deal, Citigroup said it will offer to convert nearly $27.5 billion in preferred stock sold to private investors and the public and up to $25 billion in preferred stock bought by the government into common stock. The exchange, if fully executed, would leave the U.S. government with 36% of the bank's shares. Existing shareholders' stake would be cut to 26%. Shareholders will have to approve much of the common stock issuance.

Additionally, the government is demanding that the company overhaul its board of directors. Citigroup's board will soon include a majority of new independent directors, the company said Friday. Chief Executive Vikram Pandit is expected to keep his job under the agreement.

The bank's stock plunged on the news.

The terms are onerous for both sides. While common shareholders will see their stakes severely diminished, preferred shareholders are being asked to swap their holdings for riskier common stock, whose holders are the first to get wiped out in times of trouble.

Neither has much choice, however. To motivate investors to sign up, Citigroup is suspending its payment of dividends on preferred stock. And to spur common shareholders to vote for the deal, Citigroup will issue securities to preferred shareholders that agree to the swap that let them buy common stock for a penny a share if shareholders don't approve the deal.

The swap won't involve any additional investment in Citigroup by either the government or the private shareholders, but will boost the bank's tangible common equity ratio, which is closely watched by analysts. It will also relieve the bank of the need to pay more than $5 billion in annual preferred stock dividends.

"This securities exchange has one goal -- to increase our tangible common equity," Chief Executive Vikram Pandit said.
[Citigroup Center in New York] Bloomberg News/Landov

A pedestrian walks past the Citigroup Center in New York.

Separately, Citigroup announced it will record $10 billion in write-downs for the fourth quarter, boosting the year's net loss to $27.7 billion. Citi is also suspending dividend payments on common shares, which had already been slashed to 1 cent a share per quarter.

The conversion rate for swapping the preferred stock to common shares is $3.25, a 32% premium to Thursday's closing price.

The Treasury will only convert its preferred stock into common shares if other preferred-stock holders -- namely sovereign wealth funds that plowed billions into Citigroup in early attempts to bolster capital levels -- also do so. Holders including the Government of Singapore Investment Corp. and longtime shareholder and Saudi Prince Alwaleed Bin Talal are among those of have said they will participate in the exchange.

Treasury said it will match private investors' conversions dollar-for-dollar.

"Treasury will receive the most favorable terms and price offered to any other preferred holder through this exchange," the department added in the statement.

If the maximum conversion levels are hit, that would boost Citi's TCE from the fourth quarter's $29.7 billion to as much as $81 billion.

The agreement marks the third time since October that Washington has come to Citigroup's rescue. Since then, the government has pressured Citigroup to partially break itself up by selling big chunks of its businesses and to overhaul its board. But U.S. ownership has also created a murky situation in which it's unclear who's in charge, leaving Citigroup executives often groping for guidance.

Citigroup will still have to endure the so-called "stress test," which examines banks ability to withstand various chilling economic scenarios, and could be required to raise additional capital.

The company will reconstitute its board to include a majority of new independent directors. It said of the 15 current directors, three will not stand for reelection and two will reach retirement age, and it will announce new directors soon.

Citigroup Chairman Richard Parsons has been scrambling to lure new directors. That has proven an uphill battle, with two candidates Citigroup approached rebuffing the overtures, according to people familiar with the matter.
—Deborah Solomon and David Enrich contributed to this article.

Write to Kevin Kingsbury at kevin.kingsbury@dowjones.com and Maya Jackson Randall at Maya.Jackson-Randall@dowjones.com

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Bob DeMarco is a citizen journalist, blogger, and Caregiver. In addition to being an experienced writer he taught at the University of Georgia , managed on Wall Street at Bear Stearns, was CEO of IP Group, and is a mentor. Bob currently resides in Delray Beach, FL where he cares for his mother, Dorothy, who suffers from Alzheimer's disease. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. His content has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, BlogCritics, and a growing list of newspaper websites (15). Bob is actively seeking writing assignments and syndication.

More from All American Investor

Ray Dalio on the current state of affairs in the market

Homebuyer Credit Won’t Stabilize Market, Analysts Say

Roubini Predicts U.S. Losses May Reach $3.6 Trillion

Six Errors on the Path to the Financial Crisis

Who Caused the Financial Crisis?

Option ARM--The Toxic Mortgage

Debt Binge--The Perfect Financial Storm

Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now

Bank Stress Test Economic Scenarios and Questions

The Bank Stress Test Questions and Purposes

Why are supervisors performing the capital assessments?

A: The U.S. Federal bank and thrift supervisors (supervisors) are conducting this exercise to determine if the largest U.S. banking organizations have sufficient capital buffers to withstand the impact of an economic environment that is more challenging than is currently anticipated.

Q2: Why is the exercise limited to banking organizations with assets greater than $100 billion? Will capital be made available to smaller financial institutions?

A: The banking organizations included in this exercise comprise the core of the US banking system representing roughly two‐thirds of aggregate U.S. Bank Holding Company assets. Eligible U.S. banking institutions with consolidated assets below $100 billion may also obtain capital from the CAP. Eligibility will be consistent with the criteria and the deliberative process established for identifying Qualifying Financial Institutions (QFIs) in the existing Capital Purchase Program.

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Also see: Bank Stress Test FAQ

Frequently Asked Questions

Supervisory Capital Assessment Program

Q2: Why is the exercise limited to banking organizations with assets greater than $100 billion? Will capital be made available to smaller financial institutions?

A: The banking organizations included in this exercise comprise the core of the US banking system representing roughly two‐thirds of aggregate U.S. Bank Holding Company assets. Eligible U.S. banking institutions with consolidated assets below $100 billion may also obtain capital from the CAP. Eligibility will be consistent with the criteria and the deliberative process established for identifying Qualifying Financial Institutions (QFIs) in the existing Capital Purchase Program.

Q3: How will the capital assessment be conducted?

A: The supervisors will conduct these capital assessments on an interagency basis to ensure that they are carried out in a timely and consistent manner. Each participating financial institution has been instructed to analyze potential firm‐wide losses, including in its loan and securities portfolios, as well as from any off‐balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two year time horizon (2009 – 2010). In addition, firms with trading assets of $100 billion or more are being asked to estimate potential trading‐related losses under these same scenarios.
Participating financial institutions will also forecast internal resources available to absorb losses, including pre‐provision net revenue and the allowance for loan losses. As part of the supervisory process, the supervisors will meet with senior management at each financial institution to review and discuss the institution’s loss and revenue forecasts. Based on those discussions, the supervisors will assess institution‐specific potential losses and estimated resources to absorb those losses under the baseline and more adverse case, and determine whether the institution has a sufficient capital buffer necessary to ensure each institution has the amount and quality of capital necessary to perform their vital role in the economy.

Q4: What scenario(s) will be used in the capital assessment?

A: The capital assessment will cover two economic scenarios: a baseline scenario and a more adverse scenario. The details provided to participating financial institutions on these macroeconomic scenarios are attached as an Appendix to these FAQs.

Q5: Which asset categories will be covered by the capital assessment?

A: The capital assessment is intended to capture all aspects of a financial institution’s business that would be impacted under the baseline and more adverse scenarios.

Q6: What will the supervisors do with the forecasts generated by the participating financial institutions? Will these forecasts be accepted at face value?

A: Supervisors will carefully evaluate the forecasts submitted by each financial institution to ensure they are appropriate, consistent with the firm’s underlying portfolio performance and reflective of each entity’s particular business activities and risk profile. The assessment of the firm’s capital and the size of any potential needed additions to capital will be determined by the supervisors.

Q7: What is the key capital measure/objective that will be targeted in the capital assessment?

A: The assessment of capital adequacy considers many factors including: the inherent risks of the institution’s exposures and business activities, the quality of its balance sheet assets and its off balance sheet commitments, the firm’s earning projections, expectations regarding economic conditions and the composition and quality of its capital.

Specific factors supervisors consider include: uncertainty about the potential impact on earnings and capital from current and prospective economic conditions; asset quality and concentrations of credit exposures; the potential for unanticipated losses and declines in asset values; off‐balance sheet and contingent liabilities (e.g., implicit and explicit liquidity and credit commitments); the composition, level and quality of capital; the ability of the institution to raise additional common stock and other forms of capital in the market; and other risks that are not fully captured in regulatory capital calculations.
Under current rules for bank holding companies, supervisors expect bank holding companies to hold capital above minimum regulatory capital levels, commensurate with the level and nature of the risks to which they are exposed. That amount of capital held in excess of minimum capital requirements should be commensurate with their firm‐specific risk profiles, and account for all material risks. The assessment of capital under the two macroeconomic scenarios being used in the capital assessment program will permit supervisors to ascertain whether the buffer over the regulatory capital minimum is appropriate under more severe but plausible scenarios.

Q8: What will be the source of capital if supervisors determine that a banking organization requires an additional capital buffer?

A: An institution that requires additional capital will enter into a commitment to issue a CAP convertible preferred security to the U.S. Treasury in an amount sufficient to meet the capital requirement determined through the supervisory assessment. Each institution will be permitted up to six months to raise private capital in public markets to meet this requirement and would be able to cancel the capital commitment without penalty. The CAP convertible preferred securities will be converted into common equity shares on an as‐needed basis. Financial institutions that issued preferred capital under Treasury’s existing Capital Purchase Program (TARP 1) will have the option of redeeming those securities and replacing them with the new CAP convertible preferred securities.

Q9: What recourse does a financial institution have if it disagrees with the outcome of the capital assessment?

A: The capital assessment is part of the supervisory process and thus subject to the same framework used for bank examinations or bank holding company inspections. There will be ample opportunity for discussions between the financial institutions and supervisory agencies regarding the loss estimates and earnings forecasts during the capital assessment process.


Q10: When will the process be completed?
A: The Federal supervisory agencies will conclude their work as soon as possible, but no later than the end of April.

Appendix ‐‐ Macroeconomic Assumptions

For implementation of the supervisory capital assessment program, the baseline assumptions for real GDP growth and the unemployment rate for 2009 and 2010 are assumed to be equal to the average of the projections published by Consensus Forecasts, the Blue Chip survey, and the Survey of Professional Forecasters in February. This baseline is intended to represent a consensus view about the depth and duration of the recession. Given the current uncertain environment, there is a risk that the economy could turn out to be appreciably weaker than expected than in the baseline outlook. To aid financial institutions in their ongoing risk management practices, the supervisors have also put together an alternative “more adverse” scenario. By design, the path of the US economy in this alternative more adverse scenario reflects a deeper and longer recession than in the baseline. The consensus expectation is that economic activity is likely to be better than shown in the more adverse alternative; nonetheless, an outcome such as the alternative cannot be ruled out.

The assumptions for the baseline economic outlook are consistent with the house price path implied by futures prices for the Case‐Shiller 10‐City Composite index and the average response to a special question on house prices in the latest Blue Chip survey. For the more adverse scenario, house prices are assumed to be about 10 percent lower at the end of 2010 relative to their level in the baseline scenario.



The “more adverse” scenario was constructed from the historical track record of private forecasters as well as their current assessments of uncertainty. In particular, based on the historical accuracy of Blue Chip forecasts made since the late 1970s, the likelihood that the average unemployment rate in 2010 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. In addition, the subjective probability assessments provided by participants in the January Consensus Forecasts survey and the February Survey of Professional Forecasters imply a roughly 15 percent chance that real GDP growth could be as least as low, and unemployment at least as high, as assumed in the more adverse scenario.
2 Based on the year‐to‐year variability in house prices since 1900, and controlling for macroeconomic factors, there is roughly a 10 percent probability that house prices will be 10 percent lower than in the baseline by 2010.

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Zombie Bank Defined and Discussed

A Zombie Bank refers to a bank with a net worth which is less than zero, but which continues to operate because of implicit or explicit government guarantee.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.--Paul Krugman

In the continuing series on the lexicon of financial misfortune, Morning Edition introduces the term "zombie bank." A zombie bank keeps draining bailout capital from the government but doesn't respond with any meaningful lending that helps the economy recover. The prevalence of zombie banks made the long Japanese recession of the 1990s especially painful. --Zombie Banks Feed Off Bailout Money/NPR/Listen

The global recession manifests itself in big and small ways, most gloomy, some quirky and often reflecting the inventive human spirit. Here is a look at some signs of the times.--Zombie banks return

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Wall Street Voodoo

By PAUL KRUGMAN
Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse. Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.


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