The results of the much-anticipated bank stress tests are finally set to be released on Thursday -- after the markets close. But we can already give the Obama economic team a grade for the way the tests have been handled: F.
For starters, why the holdup in releasing the results? It's been ten days since the Treasury Department and the Fed let the banks in on the preliminary results of the tests. So how come the public -- you know, the ones who keep bailing out the banks -- are still, ten days later, in the dark?
The reason is, the banks are using this time to negotiate how much information about their portfolios the hoi polloi will be privy to, and are trying to get the government to reconsider its analyses (which are already iffy, since they are based on the banks' own estimates and on assumptions about the economy - including unemployment rates, and cumulative real estate and credit card losses -- that are hardly stress-inducing). This is the equivalent of a teacher giving a student a look at his grades and allowing the student to try to cut a better deal before report cards are sent home to mom and dad.
It shows how out of whack the power dynamic is when it comes to the administration and Wall Street. In the natural pecking order, regulators are above the regulated. They don't ask for permission. And they certainly are not worried about ruffling any feathers.
But for some reason -- the Wall Street-centric bias of Tim Geithner and Larry Summers, perhaps, or, as Joseph Stiglitz puts it, the government's confusion of "the notion of too big to fail with the notion of too big to be financially reorganized" -- the banks continue to hold the upper hand (see the cramdown debacle).
The delay in releasing the test results also opens the door to potential funny business, with some troubling insider-trading scenarios and a huge payoff, as David Min at the Center for American Progress points out.
We've already seen Goldman Sachs raise eyebrows with its sale of $2 billion in non-government-guaranteed bonds last week -- a move that sidestepped its agreement with the government not to disclose the results of its stress test, instead sending a signal to investors that there was no bad news in the stress test for Goldman. Of course, Goldman's receipt of $10 billion in TARP funds and $29 billion in bonds backed by the FDIC might have something to do with how well it is doing.
Goldman is typical of the banks' have-it-both-ways approach. By announcing its intention to repay the TARP money it received (thus freeing itself from government compensation restrictions) while continuing to issue government-backed bonds, the banking giant is acting like a man who wants all the benefits of being married while still being able to slip off his ring and have an affair anytime he feels the urge.
And then there is the trouble with the assumptions at the heart of the stress tests. As Nouriel Roubini put it: "These are not stress tests but rather fudge tests... The results of the stress tests -- even before they are published -- are not worth the paper they are written on."
Nassim Taleb agreed: "This stress test is the equivalent of testing the Brooklyn Bridge by running a single heavy truck on it."
The ongoing horse-trading between the banks and the government has only exacerbated the mistrust, creating what the New York Times' Andrew Ross Sorkin, appearing on Charlie Rose, described as a lose-lose:
"Either you are going to be very realistic, perhaps even too realistic for many people, and you're going to suggest that some of these banks really are insolvent...or you're going to decide that the entire process is a whitewash and you're going to have no confidence in the test to begin with."
When it comes to assessing the health of America's financial system, can there really be such a thing as being "too realistic"? Tim Geithner clearly thinks so. So we are left with the whitewash verdict -- putting us pretty much right back where we started.
"This financial crisis," wrote Roubini, "was one due to opacity and lack of transparency in financial markets and due to regulators that were asleep at the wheel. But now the administration officials and regulators have decided to add to the fog of opacity by adding to the lack of transparency in financial markets."
And that lack of transparency extends to the artificial choices we are being offered. The way the financial crisis has been presented, there are only two alternatives: either taxpayers keep funneling endless billions into the banks or the banks go under.
But there are other options -- options that are infinitely better for taxpayers -- that are not even being considered.
The simplest and the most sensible option -- converting debt into equity -- was neatly laid out on Charlie Rose by hedge fund manager Bill Ackman:
"What's interesting is that the banks in this country have all the capital they need. The problem is too much of that capital is in the form of debt, not enough is in the form of equity. The way we solve that problem typically in America is through a reorganization process, where a judge adjudicates a bankruptcy or some other form of conservatorship or reorganization. They figure out the value of the firm. They figure out how much equity needs to be raised and they compromise with the bond holders until the bond holder end up owning the firm." Ackman called this "a classic restructuring approach."
Then why isn't this classic approach -- forcing bondholders to take a haircut -- even on the table? Joseph Stiglitz says it's because bondholders "would prefer the taxpayers giving them money... And their voice has been heard very clearly. But it's not in our national interest."
Once again the question comes down to who is supposed to take the risk: taxpayers or investors?
The rules of capitalism are clear on this: the burden must be borne by the investors who, looking for big profits, assumed big risks. Geithner, Summers, and the banks prefer rewriting the rules so that investors get the upside and taxpayers the downside.
That's not capitalism, and it shouldn't be allowed to continue. Just as the banks should not being allowed to call the shots on everything from cramdowns to the stress tests.
The Obama administration's ongoing loyalty to Wall Street is a virus that holds far more danger than the swine flu (sorry, the H1N1). And the fact that the stress test results to be released on Thursday are unlikely to show the full extent of the sickness of our financial system is one more symptom that Obama's economic team needs to be put in quarantine -- and replaced by people willing to put the public interest ahead of the interests of Wall Street.