Stress-test sceptics make bank reveal many junk investment

As bank executives flooded the briefcases of Treasury and Federal Reserve investigators with brightly-coloured charts, spreadsheets and long presentations, the authorities’ predictions of losses on anything from credit cards to mortgages fell.

But on one point, the 19 financial groups involved in the tests made little inroads with the officials charged with forecasting the lenders’ capital requirements should the economy worsen in 2009 and 2010: the banks’ own earnings predictions.

In some cases, the discrepancy between the companies’ numbers and the authorities’ findings was marked. Citigroup, for example, told investors its earnings over the next two years could total about $80bn, substantially more than the $49bn forecast by the authorities.

Admittedly, Citi, which will have to add $5.5bn in additional equity after the tests, did not include future writedowns in the forecast – a move that boosted its earnings predictions. But Ned Kelly, its chief financial officer, also complained that the authorities had given the bank “less credit than we would have hoped for . . . expense reductions efforts”.

Bank of America, found to have the biggest capital shortfall at $33.9bn, made similar noises, and even banks that were found not to need any capital, such as JPMorgan Chase, said they would earn more than the authorities think.

Howard Atkins, chief financial officer of Wells Fargo, spoke for many of his colleagues when he decried the government’s view of his bank’s profits.

“The Fed’s results differ considerably from our results,” he said. “We’ve had a 20-year record here at Wells Fargo and if there’s one thing we do know, it’s revenue.”

Scott Siefers, analyst at Sandler O’Neill, said: “If anyone can generate the several billion dollars of excess capital internally, it is Wells Fargo. We may not like the quality of earnings in the next couple of quarters, but it will evidently result in very solid tangible book value creation.”

Solving Economic Crisis by financial measures

Various finance measures have been implemented since the beginning of the worldwide economic crisis - most aimed largely at revitalizing dying businesses and corporations hit hardest by the repercussions. Many people have just a fuzzy idea of what the whole fuss is all about, but most of us would agree that the crisis that has exploded has had tremendous influence and effects at almost every level. Listening to the news during the height of the initial stages probably felt a little unreal, as the big, famous corporations once thought to be invincible were all suddenly declaring bankruptcy and loss.

These reports usually involve numbers and sums of money so large as to defy imagination: millions, billions, and even trillions of dollars seemed to be getting thrown around willy-nilly. The truth is, although over the course of a normal day we might not realize it, the functioning of economies and financial systems involve the trading of large and even larger amounts of currency. They only attracted the spotlight and public attention (and perhaps caused confusion) once critical levels were reached, enough for the normally distant economic sphere to intersect with that of daily life. But the first thing to realize is that the movement of such seemingly unreal amounts is, in fact, well within the normal working conditions of the market.

Now, with that out of the way, the next question would probably be what was the cause of the entire crisis anyway? What was that initial mistake or flaw or fall or "first domino" that triggered the whole tragic landslide? This is a difficult question with no simple answer. If you have been somewhat keeping up with the news, terms such as subprime mortgages and collateralized debt obligations might sound familiar. Explaining in detail the various financial constructs and processes that are involved would be a little too much, but essentially, it all boiled down to good old-fashioned greed.

The financial market revolves around the use and investment of so-called capital or money. Investors and the brokers that represent them always aim to maximize their profits while minimizing losses, all the while tolerating some moderate value of risk, depending on the parties involved. As it happened, the economy grew, and investors came to have large amounts of capital. Hence, the demand for investments also grew, especially those with high rates of return. Bankers and other financial institutions gladly created just such investments by transferring the risk on mortgages. Long story short, when the mortgages were not paid off, as they were bound to be, the whole house of cards collapsed, and many firms found themselves grinding to a halt.

The massive injections of capital therefore aim to increase liquidity, or to stimulate once again the movement of money that constitutes a properly functioning economy. These and other such finance measures are unfortunately not surefire ways to deal with the system wide crash. Still, they represent the best efforts of some of our most esteemed economic minds and powerful figures, and we can only wait and hope for the best.