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Bank Stress Tests Prove Banks Are Insolvent

By: Steve Johnson

5/11/2009 - 11 Comments

Last week the government released the results from the bank stress tests that were conducted to determine if the major US banks could survive a deepening recession.

The Fed stress test determined that 10 of the 19 critical banks need to raise an additional $75 billion to whether the recession.  If that were true, then why does Obama’s budget still have $250 billion set aside for more bank bailouts?

Who are they kidding?

Most of these large banks still have billions in mortgages that are worth much less than they claim.  It was just two weeks ago that the government changed the mark-to-market accounting rule which now allows banks to put their own value of their mortgages regardless of the actual market value. 

This accounting change was responsible for the first 1000 point gain in the stock market rally, but it didn’t change anything.  The assets are not worth what the banks claim just because they say they are anymore than I can say I’m worth a million dollars, while the truth is far from my claim.

The truth is that these 19 major banks that are deemed critical by the government are still insolvent, which means that they are bankrupt. Their debts are higher then their assets and there income is not sufficient to pay for the interest on their debts. 

Yet the government has said they will not let even one of them fail.  The Fed will print, borrow or steal (inflation) the money that is needed before they let any of these banks fail, because of the political and economic fallout.  Failing to let these failed companies fail is perhaps the largest economic failure that the government can make.

It is in keeping these banks around that will be far more devastating to the economy in the long run than if they let them fail.  But what 4-year politician can be expected to make long term economic decisions?  The best decisions for long term growth of the economy are political suicide.

Too Many Banks

At the same time, the economy does not need all these banks anymore, just as we don’t need 14 million automobiles anymore.  Obama said it himself; the financial industry will drastically shrink over the next several years. A few years ago, there was a mortgage lender and a car dealer and a bank on every block.  The mortgage lenders are gone and the car dealers are closing so why do we still need all the banks? If nobody is borrowing, why do we still need 8000 some banks?

If the government is going to bailout the largest banks that are deemed critical and the smallest banks and Credit Unions will survive because they didn’t get involved in high risk assets classes, then the obvious target for contraction is the mid-size banks.  The middle class banks are in deep trouble as the cards look to be stacked against them. 

Raising Capital

The results of the stress test suggested that the banks needed to raise another $75 billion in capital.  Because of the resent market rally, the banks response was ‘no problem’.   What that means in that the banks are going to issue $75 billion worth of stock that they will sell to investors.

The newly issued stocks will add to the existing stocks already sold to investors, which means the value of current stock holders will lose some value because the value of the banks didn’t change, just the amount of stock they have in circulation. 

The reason that banks believe they can easily sell $75 billion of stock is because the demand for their stock has been increasing in the past several weeks.  I’m not sure why, but for some reason a lot of people think these banks are somehow going to find a way to increase their revenue and improve their balance sheets.

But that is very unlikely if you consider most of their earnings for the past decade have been based on increasing mortgage values, refinancing mortgages, trading stocks and credit cards.  All of these are contracting. 

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