The Stress Tests: The Administration's Real Strategy

The stress tests give away the administration's real financial strategy. It is, in sum, as little intervention in the banking system as possible. In other words, there is not much to fix, so let's just get it working again. In other 'other' words, let's bumble along.

The stress test was more or less designed to yield a foreordained result. The banks were graded on a curve. So many banks get an A, so many a B and C, and a few get a D. None gets an F.

Thus, the idea was that no bank need be reorganized by the federal government. All banks designated as needing to raise capital will be able to do so on their own -- most likely.

We shouldn't be too cynical. We now at least have some information about what's on those balance sheets. Hard as it is to believe, the TARP program was rolled out with no serious knowledge of the quality of bank portfolios of assets.

The success of the strategy in the short run will entirely rest, not on the stress tests, but on whether the economy is soon to come back, thus limiting high default rates on mortgages, commercial real estate, business loans, credit card debt, and so on.

It is possible that it will. The Federal Reserve has done an awful lot. The Obama stimulus is now making its way through the economy. The housing plan is reducing mortgage payments for some, freeing up money to be spent or at least to avoid default. The two things that make this period different than the 1930s is that, first, back then, they raised interest rates and refused to pump up the economy through government spending. Second, those New Deal programs like Social Security and unemployment insurance are today significant automatic stabilizers, rising or at least staying the same as the economy sinks.

And banks are indeed making profits in the operating part of their business. They are making losses on their old bad investments, mostly in mortgages assets. They may climb out.

But is this the financial system we want? It is being subsidized to live another day -- and encourage same dangerous investing as before. Oh, the bankers won't do as much for a while, but give them a year or two.

We want a system that does not use savers' federally insured money to invest over-aggressively so that individual bankers can make enormous bonuses. We want a system that will limit the recently famed "Minsky moments," the bubbles which many now agree are the inevitable result of loosely regulated financial systems.

The stress tests make it sounds like the banking system is at least okay. It is the grade the administration wanted, thinking it would make Wall Street confident again. It was like Greenspan and Rubin appeasing the bond traders in the 1990s -- only more is at stake. The banking system is not okay, even if we begin to recover now. Imagine if the Depression ended in 1931. The critical reforms to the nation's future did not begin until 1933.

Comments

[Carolab]

On April 23, 2009, Stephen Zarlenga, director of the American Monetary Institute, delivered two briefings on Capitol Hill on the American Monetary Act that may be introduced as legislation during the current congressional session.

Act is here: http://mygodimhit.com/bill.pdf

This single measure has the potential of bringing together the tens of millions of people who have realized it"s our bank-run debt-based monetary system that lies at the center of the financial rot that is destroying our republic and its values.

Attending the briefings were congressional staffers and members of the public. Zarlenga was introduced by Congressman Dennis Kucinich (D-OH), who has spoken in favor of wholesale reform of the monetary system on the floor of the U.S. House of Representatives.

The main thrust of the act is to replace the bank-centered debt-based monetary system with the direct creation of money by the federal government which would spend it into circulation as was done with the Greenbacks of the latter part of the 19th century.

The money would be spent on all types of legislated government requirements but would focus on infrastructure improvements, including education and health care. The act not only would create a new monetary supply denominated in U.S. Treasury notes, but would rebuild our job base which has been outsourced to other nations by the globalist corporations and big financial interests.

http://www.pdamerica.org/articles/news/2009-05-09-12-15-56-news.php

[StephenJK]

Interesting how people like to debate the bailout policy and the stimulus policies. Yet, no one recognizes why we're in this problem to begin with: a hijacked political infrastructure controlled by a handful of wealthy power elites. Attempts to wrest power from the Fed have been stopped (see JFK assassination) in the past and now the government is in FULL control by these psychos. We're being sold up the river for a VERY long time to come. There is only a couple goals they have in mind; increase their insane pools of wealth and maintain their grip on government policy that provide means to those ends. There are some very smart commenters here who think going along with this plan is the correct course of action. The elites couldn't agree with you more.

[getsmart86]

Dead on. An even bigger problem looms. The government is pushing on a string. The simple question we must ask is what will be the engine to promote productivity, keep people employed and increase the savings rate? Nada. Greenspan used real estate to promote a fictional recovery. What is left?

[Reighben Labilles]

Confidence goes a long way in the financial system. It motivates investors to conduct business again. As compared to showing how fundamentally flawed the banks are and scare all the investors away. But Obama's government still needs to put measures within these banks so that this downfall won't repeat itself. The banks cannot walk away from the bail outs without giving something in return. The lesson is no more high-risk gambling with the stocks and funds. Regulations should be implemented to prevent further abuse.

[citizenzeus]

Clearly we are in the bargaining stage of grief. I believe anger is just around the corner after these trillions and more are wasted down a rat hole. Looking forward to the time acceptance brings us to real reforms, not these charades. I wonder how much heat Obama is going to receive when these fail. If he's smart he'll stay cool and say, "Well, these didn't work. Conventional approaches did not do the trick. Now time for the progressive stuff, everyone actually elected me for. Unfortunately, we're way ahead of him on this. I hope the entire nation does not have to go down before we have single-payer health care and real regulation, transparency, and accountability in the banking system.

[BurtonOerney]

I think I'm starting to understand. You think that Treasury was supposed to get banks to agree to new regulations in exchange for the bailout money. Is that right? If it is, I don't think that was ever the plan.

Did anybody notice how much agony went into allowing banks to not use mark to market for a while? The Congress was involved, there were hearings. The whole thing had been going on for a couple of months before Obama even took office. That was one accounting rule. I can't see how Congress, Treasury, the SEC and the administration are supposed to completely revamp the entire industry before we've evan had our equivalent to the Pecora hearings. Nobody already has a complete list of regulations that need to be put into place. Maybe we should have hearings to come up with that list before we start putting imaginary new regulations into place.

[Caliwoman]

What if we all started making something?

[elmoor]

Does the writer of this article not pay any attention to the numerous statement by President Obama that new regulatory system will be in place by the end of the year. Could you give 'em a minute, please!

You have to stabilize the patient-- which the Obama administration seems to have done-- and only THEN do you begin the reconstructive surgery.

Patience...

[Bonobo]

If we're going with medical analogies, this would be more akin to bandaging cuts on the guy who stopped breathing. The regulatory system cures future incompetence. Doesn't help with the immediate toxic asset credit crisis which has frozen up commercial lending.

[BurtonOerney]

Glimmers of improvement were most notable in commercial lending. The Fed said 40% of the 53 domestic banks it surveyed between March 31 and April 14 said they tightened standards on commercial and industrial loans, a smaller percentage than the 65% that said in January that they tightened standards.

"The April survey marks the first time since January 2008 that the proportion of banks reporting such tightening fell below 50%," the central bank said.

banks tighten standards, they make it harder to get a loan by toughening certain criteria, such as for income, cash flow or indebtedness. Banks were also a little less aggressive about demanding more for the loans they actually made. Some 80% said they toughened terms on loans -- for instance, increasing the interest rate -- when compared with some benchmark. That was down from the 95% that said in January they demanded a higher rate.

-Wall Street Journal, May5

Also, some commercial loans are now eligible for TALF funds. Frozen is not the word to use anymore.

[BurtonOerney]

Yeah, I don't know what's going on with HP and the stress tests. I guess the boss took the position that everything this administration has done is a complete failure, that we'd be no better off had we done nothing. Oh, those darned fat cats! Seriously, should we have started by trying to put an entirely new regulatory system in place before recapitalizing the banks? I think Hungary, Ireland and Iceland would beg to differ.

[Bonobo]

Several of us posters, and other commentators, have proposed alternative strategies, including direct lending, capitalizing small lenders, and receivership, among others. It just strikes some of us that pouring money into giant mindless money pits is a really bad idea.

[burndtdan]

I don't share your optimism... I see no reason to conclude the banks would even take "a year or two" before going right back to their old games.

[Bonobo]

Madrick is saying that is possible that the economy may come back, AND the financial oligarchs will return to their old ways (actually, it's hard to see how they've stopped). It isn't really optimism, since it just means fundamental problems have been pushed down the road a couple years. Given how much stimulus money has been printed and borrowed, if we don't see the Main Street equivalent of a dead cat bounce in the last part of the year, things are really screwed.

[Vinca]

When you afraid to trust banks, afraid to trust the stock market.afraid of a robber if you hid your money in your house. What's one supposed to do, to keep from losing all they have managed to save?

[muckraker3]

This is a disgrace. Any time this oligarchs on Wall Street blow themselves up they steal trillions from the taxpayers to pay for thier losses. They then continue with their lavish bonuses as though nothing has changed. They do this through their former employees now ensconced throughout the Treasury and Fed. The politicians move through the revolving door from hedge funds to high level government positions. Obama is wall streets biggest friend. Bankruptcy for Chrysler and GM. Bonuses for AIG and Goldman. I am amazed that unions continue to be foot soldiers in the democratic party. Some day in the not too distant future this whole cancerous system will come crashing down.

[Tena]

What I don't see in hardly any articles or posts on the financial crisis is an acknowledgment that we have an obligation to the rest of the world to stabilize our market, our credit rating, out major investors because those institutions have direct effects on all the other global financial systems.

[StephenJK]

Yeah? Maybe it's time to do away with the "global financial systems" that are in place because they are the cause of this massive systemic failure.

[Tena]

What I want is regulation, specifically, another Glass-Steagal Act that could prevent this kind of crash.

That's not up to the banks or the president. That's up to Congress, though I have heard Obama say repeatedly that we need new regulation and I think we'll get it. But I think first they had to stop the bleeding that started with Lehman Bros' collapse.

We were pretty damn close to big runs on banks there for awhile and that wouldn't have helped.

[StephenJK]

Yeah I guess you don't do history. Especially, financial history.

[clarryr]

To me, this is the telling question:
"But is this the financial system we want? It is being subsidized to live another day -- "

The absolute worst time to redesign a system is in the middle of a crisis when the current system is failing. It would be like trying to redesign the Titanic right after it hit the ice berg a thousand miles away from the nearest drydock.
Transforming the financial system so that it returns to a boring 10% of the GDP instead of the fragile, current 40% of the GDP will take years - 4 at least I would think. Re-regulation has to take place, all of those derivatives have to be dealt with, and all that debt has to be addressed. Meanwhile, letting the current system collapse would throw the world into a worse depression that the Great one.
My opinion is it's better to help the current system limp into drydock while we intelligently design it's replacement.

[sposton]

The problem with your solution is that the day for solving the problem never comes - you either never get to the dry dock or after you get there you patch a few holes and relaunch a ship which has no business being afloat. When the things are bad it is too risky and when things are good we should not rock the boat and ruin the good thing. The reality is that we can do more than one thing at the time. We don't have to do all things at the same time but we should be able to design a system that we want and then start working towards that goal. The problem with accepting your solution is that we are never able to tackle the fundamental reevaluations of what we have and what we ought to have. The inertia of self-interest takes over and nothing or too little is done.

[clarryr]

Ok I buy into that. The truth is we ARE actively working on the solution as well as the rescue. Note that Obama and Geithner have called for re-regulation and Congress has promised a bill by the end of the year. But that is only a start. It is not possible to design and implement a complex system to replace the existing one. You cannot one day stop the old and the next day start the new. That is the nature of large complex systems, they evolve. We need to be smart enough to direct that evolution in a manner that we get acceptable results without too many unintended consequences and without killing the patient in the process.

[sposton]

Our impotence to deal with these issues on the systems level is obvious. The ingrained interests will always tell you this is not the time to do anything "drastic". When the times are good they tell us not to rock the boat. When the times are bad they tell us that we cannot afford to do anything now - it is just too risky. In this way the they continue with a system that is designed to enrich a few to the detriment of the rest of us.

There are two basic problems. Number one is that the capacity of our model of capitalism to inflict incredible damage onto us. If it continues on the same development path it is easy to see its self-destruction. The other problem lies in the nature of our government. Its 18th century structure is custom designed for elites to rule over us "with our consent". This may have worked when the interests of the elites and the rest of us had a hight degree of overlap and the capacity to do systemic damage was relatively small. Nowadays, there is hardly any overlap in interests of modern elites and our interest, the capacity to do damage is unlimited, and our government is ill equipped to deal with this new reality.

If we are unwilling to tackle at these issues on the systems level we simply cannot solve our problems. These are the kinds of problems that elections just cannot solve.

[Bonobo]

The primary systemic problem our political system has is the winner-take-all by region voting structure. This effectively means the entry barrier for a political party approaches 50%, and over time leads to only two relatively stable coalitions trading power. This has two results. First, very few regions will be closely divided between the two, creating a majority of "safe" seats (counting both parties), resulting in gridlock. Second, the system becomes relatively predictable for wealthy private power players. Your campaign donation is a pretty low-risk investment.

Proportional representation systems would create much needed flexibility and responsiveness. The entry barrier is lowered significantly, and the floor below which parties cannot fall becomes much lower (right now, you can't do any worse than number 2). As it is, all Democrats have to do to retain power is not be Republicans. More competition is generally held to be good for the consumer in the marketplace, so why not in politics?

[sposton]

Excellent points. David Sirota, in his book "The Uprising", mentions fusion voting, which could also help move the system from where it is currently stuck. Interestingly, at one time most in most of our states electoral fusion was legal. I think we should fight to bring it back.

http://davidsirota.com/index.php/new-ways-of-thinking-on-election-reform/

http://en.wikipedia.org/wiki/Fusion_voting

None of this is going to happen on its own. We must join forces with people from across the political spectrum, all those who know that what we currently have is a sham.

[sposton]

An excellent book explaining different voting methods:

"Gaming the vote: why elections aren't fair" by William Poundstone

After reading this book I was convinced the range voting is the best alternative to what we currently have.

http://rangevoting.org/

[alexandra hamilton]

but on whether the economy is soon to come back, thus limiting high default rates on mortgages, commercial real estate, business loans, credit card debt, and so on.

It is possible that it will.
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Here I disagree. That's a the main problem has not been solved which is the falling wages and the loss of jobs which eat into people ability to spend. People who are in debt right now, will not be willing to add more debt to it and banks will not be willing to lend money to people who are not going to pay it back.
The US is done for. The crash is now unavoidable.

[Rule Of Law]

Correct. When you look at the answer to this crisis as being still more consumer spending--taking on even more personal debt just to keep the banks afloat--and forget to mention that job losses and unemployment are reaching historic highs, the question is simple--Where and how will we get the money to spend? Jobs gone. Homes gone. Saving gone. Lending non-existent.

Just won't happen.