May 8, 2009
Stress is Over On Stress Tests
For months the markets have suffered the uncertainty of the results of the government stress tests. Information has been leaked, by the government and by the banks themselves, about the tests and the potential results. We all saw the results delayed in announcement, reflecting the likelihood of tense behind the scene negotiations. The uncertainty of the final report created a market overhang of uncertainty. The uncertainty is over -- the markets can now price the results. Looking back there is much to comment on: First, and foremost, In theory our government disclosure regulatory pphilosophy should have made the tests redundant and unnecessary -- the existence of the tests themselves is a critique of current disclosure standards or vice versa. Second, the test is milk toast easy given current economic conditions. Third, and most important perhaps, the cure -- turning preferred stock into common-- is no cure. The cure does not raise a dime; preferred is equity -- some of it much like common (with voting rights and conversion rights anyway) -- and it stands behind all the debt. The only disadvantage of preferred is contractual -- failure to pay dividends can trigger some default on debt covenants -- and contracts can be renegotiated. Fourth, the conversion of preferred to equity will give the government ownership control of several of the banks -- a sort of defacto nationalization. It looks like the government backed into the positions but it may have been the goal all along.