Stress Tests and Baby Ducks

On April 24, the Board of Governors of the Federal Reserve System published its white paper detailing the process and methodologies for the stress tests for U.S. bank holding companies with assets exceeding $100 billion.

Bloomberg News reporter Lizzie O’Leary was at the Fed to cover the story, and she was walking by one of the two fountains outside the Fed building.

Apparently someone had added too much chlorine to the water. Eight dead ducklings floated in the fountain. Paddling near the fountain’s edge, the mother tried to shield her one surviving child. The groundskeeper cleared the dead ducklings out of the fountain and then helped the mother and her one surviving duck out of the fountain.

Let us be optimists and assume that this sad tale is a metaphor for the calamitous times from which we’re emerging.

The stress tests completed, ABC News’ Matt Jaffe reports that an industry source says that the Federal Reserve has told at least seven of the 19 banks to bolster their capital levels by at least $65 billion. Bank of America Corp. will need to raise $34 billion in capital; Citigroup Inc. will need to raise $5 billion; GMAC LLC, $11.5 billion; Morgan Stanley, $1.5 billion, and Wells Fargo & Co. around $14 billion.

"None of those 19 banks are at risk for insolvency," Treasury Secretary Tim Geithner underlined for Charlie Rose last night.

Geithner acknowledged that some banks will argue the tests were too tough, while critics will complain the tests were not tough enough. For the cases when supervisors found that a bank needs additional capital, that bank will then have six months to go raise it.

"Banks will have lots of different ways to raise additional capital," stated the Treasury chief. "They could go raise new common equity from existing shareholders or from new investors. They can seek to convert or exchange some of their existing securities, capital securities, into common equity. They can come take capital from the government, apply to take capital from us. And we will, again, we’ll backstop and reinforce that process. And I am reasonably confident that the vast bulk of these additional needs, these guys will be able to meet through private means. And they’ll have a big incentive to meet through private means, and that’s good for us, too, because we don’t want to create a situation where the government has to come in, except where that’s necessary."

Ultimately, Geithner said the stress tests are all about reducing uncertainty and increasing confidence, especially since these 19 big banks hold about three-quarters of the assets on bank balance sheets.

Most of the banks — including American Express Co., Bank of New York Mellon Corp., Capital One Financial Corp., Goldman Sachs Group Inc., J.P. Morgan Chase & Co., and MetLife Inc. — will not be required to raise additional capital.

"For the first time ever, we brought the nation’s financial supervisors together, and in an unprecedented step, asked them to do a careful look under the hood, to take a careful look at how much — how strong these institutions were in the event things got worse," Geithner told Rose. "And what these results will do is they will bring in a level of transparency to bank balance sheets that will allow investors to judge, make it easier for them to raise capital, improve confidence that this system is going to be strong enough to get through this, and that will be enormously helpful. It will be an important next step forward. Again, because of the virtues of bringing disclosure and transparency, it will help lift this fog of uncertainty over the financial system, and I think the results will be, on balance, reassuring."

Geithner said that "things feel better" about the economy." People sense a bit more stability. You can see it in behavior. People are spending a bit more. Investors — companies are starting to borrow again so they can start to make investments again. It does feel better, but I think we emphasize that there is a lot of pain across this country, still. Enormous uncertainty, people going through what is probably the most challenging period, still, in a generation. It took us a long time to get into this, and it’s going to take us a lot to get out of this still."

– Jake Tapper and Matt Jaffe