Interest Rate Roundup

Wednesday, April 15, 2009

This isn't Lake Woebegon. Not all banks are above average!

The attitude of the administration toward the results of the so-called "stress test" of the country's 19 biggest banks seems to change every day. Will the results be kept secret? Will we just get aggregate data, or will we get an institution-by-institution breakdown? How much data will the public be given? Those are questions that policymakers have been wrestling with.

The latest thinking, according to stories in the New York Times and Wall Street Journal, appears to be that more information -- rather than less -- will come out. Per the Times:

"The Obama administration is drawing up plans to disclose the conditions of the 19 biggest banks in the country, according to senior administration officials, as it tries to restore confidence in the financial system without unnerving investors.

"The administration has decided to reveal some sensitive details of the stress tests now being completed after concluding that keeping many of the findings secret could send investors fleeing from financial institutions rumored to be weakest.

"While all of the banks are expected to pass the tests, some are expected to be graded more highly than others. Officials have deliberately left murky just how much they intend to reveal — or to encourage the banks to reveal — about how well they would weather difficult economic conditions over the next two years.

"As a result, indicating which banks are most vulnerable still runs some risk of doing what officials hope to avoid."

The Times article also adds a bit more detail on a critical point I'll discuss in a minute (my emphasis added):

"In ordinary times, regulators do not reveal the results of bank exams or disclose the names of troubled banks for fear of instigating bank runs or market stampedes out of a stock. But as top officials at the Treasury and the Federal Reserve Bank focused on the intensity with which the markets would look for signals about the nation’s biggest banks at the conclusion of the stress tests, the administration reconsidered its earlier decision to say little.

“The purpose of this program is to prevent panics, not cause them,” said one senior official involved in the stress tests who declined to speak on the record because the extent of the disclosures were still being debated. “And it’s becoming clearer that we and the banks are going to have to explain clearly where each bank falls in the spectrum.”

"Two senior government officials said on Tuesday that they were now likely to encourage the banks to reveal a range of information, perhaps including the size of losses the banks could suffer under each of the stress assumptions. Critics of the testing system, however, have questioned whether the hypothetical cases are extreme enough."

The Wall Street Journal article also deals with this key point, saying:

"The move to stop treating banks equally is sparking concern about the effect on specific institutions seen as weaker than peers. "You can create a run on a bank pretty quickly," said Eugene Ludwig, chief executive of consulting firm Promontory Financial Group and a former Comptroller of the Currency.

"Wayne Abernathy, executive vice president of financial institutions policy and regulator affairs at the American Bankers Association, said the government needs to provide information about the results but also protect examination data.

"I don't think they can ignore the appetite they have created for this information," Mr. Abernathy said. Having the government publicize some information would allow policy makers to control the message. "It's what can we say that is meaningful while still protecting the quality of that exam data," he said.

"Mr. Ludwig cautioned that any information could give rise to mischief. "Bank exams are confidential for good reason," he said. "Given the kind of confidential information they contain, there is always the possibility of misuse or misinterpretation."

Personally, I see absolutely NOTHING wrong with making as much information public as possible. And I have absolutely no problem if people "run" from crummy banks. The current policy of giving TARP money to any and all comers, and pretending the banking industry lives in a Lake Woebegon world -- where all institutions are above average -- makes no sense.

We should want to have a system that's based on merit. We should want to know who is weak AND who is strong. We should want the weak institutions to be killed off, allowing the strong to survive and thrive. Indeeed, making "public" how weak and strong various institutions are will act as a deterrent against future dumb behavior by bankers. Bankers will know they'll be branded with a scarlet letter if they take on too much risk and lose too much money, so they'll be more careful.

Several private companies (TheStreet.com Ratings, Bauer Financial, Bankrate.com, etc.) already publish bank ratings that are based on proprietary models and formulas that measure capital adequacy, earnings, loan losses, and so on to come up with "grades." Consumers should use that information to stop doing business with crummy banks and start doing business with good ones. We should even consider going a step further -- making the CAMELS rankings that regulators use public. And if the bad banks don't like it because it puts them out of business? Tough. Stop doing dumb things and you won't get a bad rating.

1 Comments:

  • It might also be said that, if the information is not transpatant to the public, only the insiders will benefit. The rich get richer...

    G. L. Monahan

    By Anonymous G.L.Monahan, at April 15, 2009 at 8:28 PM  

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