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April 7th, 2009

Economist Calls Stress Tests “A Complete Sham”



William Black, a former regulator and S&L prosecutor, called Treasury Secretary Timothy Geithner’s stress test program “a complete sham.” Black likened the ongoing tests to a Potemkin village, a term the American Heritage Dictionary defines as “Something that appears elaborate and impressive but in actual fact lacks substance“:

“It’s a Potemkin model. Built to fool people.”

“There is no real purpose [of the stress test] other than to fool us. To make us chumps,” Black says.

Black expressed additional disdain for Geithner, calling him “a failed regulator” who has not allowed unhealthy banks to fail. The Treasury Secretary has expressed a willingness to shake up management as well as the board of directors at several financial institutions, but remains firmly committed to keeping them open and operating:

(On Saturday, Geithner said on Face the Nation, if banks need “exceptional assistance” in the future “then we’ll make sure that assistance comes with conditions,” including potentially changing management and the board, but did not say they’d be shut down.)

We first wrote about the Capital Assistance Program (CAP), a.k.a the “stress tests,” at the end of February:

The Treasury will provide the institutions with capital in exchange for convertible preferred securities, which can be changed into shares of the banks’ common stock. Banks will have six months to replace government money with private funds. The institutions will be responsible for raising private capital in the marketplace in order to cover the government’s “loan” of capital — if they can or want to.

In the instance where the capitalization and conversion results in a greater than 50% share for the government, the institution would be considered “nationalized,” at least temporarily, since the government would control a majority of the company.

While this program is designed to only be temporary, there’s a serious chance that the government won’t quickly relinquish control of an institution it “owns.”

“Once the government gets its claws into an industry, it’s often hard to get them out,” said HSH Vice President Keith Gumbinger.

What will happen if banks can’t raise enough private capital and the U.S. Government ends up becoming a majority shareholder? How quickly will the government return the firm to private ownership, and at what cost to the owners?

After revisiting our past analysis of the stress test program, it’s easy to see why Black views this program as deceptive. Time will tell if the results of the stress tests prove to be fundamentally fruitful for the financial industry, or merely a facade for Washington to ease into nationalization.

For more on Black, read his interview with Naked Capitalism.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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