Stress Test for Banks Exposes Rift on Wall St.

Stress Test for Banks Exposes Rift on Wall St. - 2/25/2009

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Stress Test for Banks Exposes Rift on Wall St.
ERIC DASH

The New York Times. February 25, 2009
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EXCERPT: Big banks keep insisting that they have all the capital they need — a claim that might strike many people as absurd at a time the government is spending billions of taxpayer dollars to prop up the financial industry. So here is a surprise: By some common measures, the banks do have enough capital. The problem is, it is not the kind of capital investors think the banks need. For years, the question of what constitutes a bank’s capital, and how to measure it, was largely academic. But the issue is coming to the fore as federal regulators start administering a tough new “stress test” to 20 large banks on Wednesday to determine how the banks would withstand a severe economic downturn. Investors in the stock market and the banks are increasingly at odds over how to assess the health of financial institutions. Where regulators side could determine the fate of many lenders, particularly big banks like Citigroup and Bank of America, whose share prices have plummeted this year on fears the government will increase its ownership of them. Until the financial system deteriorated last fall, investors focused on what is known as Tier 1 capital, which consists of common stock, preferred stock and hybrid debt-equity instruments. Now, however, they are focusing on what is called tangible equity capital, which includes only common stock, saying it is a better way to measure the risk in bank shares. The difference might sound like something only an accountant would worry about, but it lies at the heart of two questions confounding both Washington and Wall Street: Are the nation’s banks sound? And are bank shares a good barometer for the health of the financial system? … On Monday, the federal banking regulators issued a statement saying that if the stress test indicated an “additional capital buffer” was necessary for some institutions, it “did not imply a new capital standard and is not expected to be maintained.” But stock investors are homing in on tangible common equity. Whereas Tier 1 capital gives regulators comfort because it captures a bank’s ability to weather a financial storm, stock investors, who suffer the first losses, are worried about their own exposure. Tangible common equity, or T.C.E., they argue, is the best measure for them.

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