savings

Don't sweat the bank stress test results

"From a consumer point of view, I just don't think this is an issue," says John Douglas, partner at Paul Hastings law firm in Atlanta and former general counsel to the FDIC.

"If Goldman Sachs is No. 1 on the list and Bank of America is No. 19, am I going to move my money from BofA to Goldman Sachs because that's a better institution? That doesn't make any sense because BofA is going to be plenty strong and the government has said it's going to stand behind the institution.

"From an investor's point of view, I'm appalled at this exercise. This is stuff that's done routinely in banks behind the scenes between the examiner and the institution. To have it done in a semipublic fashion has not been helpful to our financial system. It causes the consumer to ask a bunch of questions that I just don't think the consumer needs to worry about."

Investors who own shares of the institutions may be spared seeing the dilution of their holdings.

 

Institutions that need to raise additional capital can swap preferred shares they issued to the government in exchange for TARP money for what's called "mandatory convertible preferred."

 

"It doesn't dilute the existing common shareholders until that preferred is later converted into common," says Greg McBride, CFA, senior financial analyst at Bankrate. "In the meantime, there is no additional dilution taking place because it's just an exchange of existing securities, not an issuance of new securities. There's nobody jumping in line ahead of you in the capital structure.

 

"When the TARP funds were issued, then-Treasury Secretary Henry Paulson basically cut in line in front of common shareholders to the tune of however many billions of dollars a particular institution needed in funding."

 

Some have criticized the stress test scenarios for not being sufficiently adverse. In an opinion piece in The Wall Street Journal, Nouriel Roubini, an internationally recognized economics expert and a professor at New York University, estimates that losses on U.S. loans and securities is $3.6 trillion and that the financial system is near insolvency. He says that U.S. banks and broker-dealers account for more than half these losses and that the stress tests' conclusions are too optimistic about the banks' health.

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