The Fed's Stress Test Was Merely The Latest "Lipstick On A Pig" Farce
Last week we learned two things: that Jamie Dimon specifically telegraphed he is now more powerful than the Fed, and that the US economy is back down to the same March 2009 optical exercises in financial strength gimmickry to stimulate rallies. Recall that on FOMC day, the market barely budged on Bernanke's ambivalent statement and in fact was in danger of backing off as the readthrough was that of no more QE... until JPM announced a major stock buyback and dividend boost. The catalyst: a successful passing of the latest and greatest Stress Test, which according to experts was "much more credible" than all those before it. Wrong. The test was merely yet another complete farce and a total joke. But as expected, the test had its intended effect: financial shares soared across the board, and banks promptly took advantage of investors and robot gullibility to sell equity into transitory strength. Bloomberg's Jonathan Weil explains.
How stressful were the Fed’s tests? One anecdote stands apart: Regions Financial Corp. (RF), which still hasn’t paid back its bailout money from the Troubled Asset Relief Program, passed.
The footnotes to the company’s latest financial statements tell the story. There, the Birmingham, Alabama-based lender disclosed that the loans on its books were worth $8.1 billion less than what its balance sheet said, as of Dec. 31. By comparison, the company’s tangible common equity, a bare-bones measure of net worth, was $7.6 billion.
So if it weren’t for the inflated loan values, Regions’ tangible common equity would have been less than zero, with liabilities exceeding hard assets. In short, the test was a joke, although it had its intended effect. Shares of Regions and other large banks soared, and Regions raised $900 million selling common shares on Wednesday. The company, which hasn’t reported an annual profit since 2007, plans to use the money to help repay the $3.5 billion it got from the Treasury Department in 2008.
Tangible common equity became the capital benchmark of choice for many investors during the last U.S. banking crisis, because the government’s main capital measures lost credibility. It excludes preferred stock, which in substance acts more like debt than it does equity. It also excludes airy intangible assets such as customer relationships and goodwill. (Goodwill is the bookkeeping entry a company records on its balance sheet when it pays a premium price to buy another.)
To calculate tangible common for Regions, I took the company’s $16.5 billion of shareholder equity and subtracted its preferred equity and intangibles. That’s how I got $7.6 billion.
Then I went a step further and adjusted Regions’ remaining net worth to get a more realistic measure. In a crisis, what matters to investors and counterparties about a company’s assets is what they are worth, not what they are carried at on the company's balance sheet. Just ask anyone who got a margin call back in 2008.
Fortunately, companies are required to provide quarterly footnotes showing the estimated fair-market values of their financial assets and liabilities, including loans and other items that appear on their balance sheets at historical cost. Factoring in those adjustments, Regions’ tangible common equity was negative $525 million as of Dec. 31.
And yet RF passed with flying colors.
It gets worse:
The Fed’s analysis, by contrast, didn’t take changes in liquidity or market conditions into account when estimating the future losses on banks’ loans or securities, except where the companies were using fair-value measurements for such assets already. A company might have large paper losses in its “held to maturity” or “available for sale” bond portfolios, for instance. The Fed said such losses only counted if they were due to a bond issuer’s inability to pay its obligations, as if that were the only factor affecting bond prices.
Similarly, were Regions to sell its loans, it wouldn’t be able to realize the $73.3 billion it showed as an asset on its balance sheet. In the footnotes, Regions estimated its loans were worth $65.2 billion using the values that “a market participant would use in a hypothetical orderly transaction.” The Fed ignored these values.
In a press release, Regions Chief Executive Officer Grayson Hall said the Fed’s capital review “demonstrates the strength of our company.” If you want to see how strong Regions really is, though, the footnotes offer a clearer picture.
Regions probably would have failed years ago if not for its federal backstop. Instead, it now has a stock-market value of $9.1 billion. Clearly the Fed wanted it to attract new investors, and those who put fresh capital into Regions this week believe the government won’t let it die. That about sums up the company’s value proposition. In other words, we’re all still on the hook.
What is sad, is that even the general public is now increasingly more aware of these outright gimmicks by the Federal Reserve-Wall Street cartel, and refuses to participate in stock rallies premised on fraud and erroneous data interpretations, forcing the banks themselves to inflate their own asset values even higher in a coordinated incestuous circle jerk of intra-Primary Dealer stock purchases, resulting in an even greater disconnect with the underlying reality. Because at the end of the day, what it all boils down to, is simple cash flow. And that, despite all the Fed's mock tests and words of encouragement, in a world of perpetual contract law abatement, is lacking more than ever. After all, why pay for something today, when the administration itself tells you not to?
Alas, the relentless encroachment of socialism is something that not even the most naive and gullible 'stress test" can mask.