Banks Have A Right Mind To Sue The Fed Over Stress Tests

Apparently said tests are illegal, according to a group whose members "include senior executives at big banks J.P. Morgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc., Wells Fargo & Co., and State Street Corp."
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House of Iniquity and Ineptitude. By Dan SmithRdsmith4 (Own workOwn work) [CC BY-SA 2.5], via Wikimedia Commons

via Wikimedia Commons

Banks have been grumbling about the Fed’s stress tests since, well, since the Fed came up with the idea of stress tests in the wake of the financial crisis: They’re too hard. They’re arbitrary and unfair. They’re running our banks for us. They hurt our feelings.

They hurt their feeling so much, in fact, that they’re even thinking about suing over it, which is a pretty drastic step, given all of the things the Fed can do to banks that displease it. But if they did sue, they’d win, according to the Harvard law professor the banks hired to tell them they’d win.

“We find that the Federal Reserve has likely not complied with the [Administrative Procedure Act’s] procedural requirements in adopting key aspects of its Comprehensive Capital Analysis and Review stress tests,” the paper says. Following those requirements “would result in better public policy outcomes and reduce the threat of a legal challenge to the Fed’s actions….”

The paper says two aspects of the tests—the assumptions the Fed makes about future scenarios and its mathematical models to project how banks will fare under the scenarios—“function as rules” because they effectively dictate the amount of equity capital banks must maintain. The Administrative Procedure Act generally requires agencies to publish drafts of their rules for public comment, but the Fed doesn’t publish drafts of the scenarios or models.

Those sorts of ideas seem to be flying around Cambridge these days, because certain Harvard presidents/Treasury Secretaries emeriti is also chiming in. Larry Summers’ verdict? All that heavy lifting has been for naught.

“To our surprise, we find that financial market information provides little support for the view that major institutions are significantly safer than they were before the crisis and some support for the notion that risks have actually increased,” Ms. Sarin and Mr. Summers wrote….

In the paper, the economists say their findings “suggest cause for concern that there is a nontrivial probability of at least a major loss in equity value by a major institution sometime in the next few years,” they wrote.

The authors attribute this primarily to the fact that the franchise value of most banks—specifically, the ratio of their stock price to book value and the market value of equity to assets—has declined substantially since the financial crisis.

Is Larry Summers, deregulator-turned-re-regulator, feeling some belated Bern and looking for reasons to blow up the banks? Not exactly.

“There is a possibility that by further eroding bank franchise value, further regulatory actions could actually increase systemic risk,” they say.

Banking Group Finds Fed Stress Tests Likely Illegal [WSJ]
New Laws Haven’t Made Big Banks Safer, Paper by Lawrence Summers Says [NYT]


Citi Will Try The Stress Test Again With A $9bn Stock Buyback

More stress tests, bleargh. I guess the news is that Citi "failed", though I can't get all that excited by that because it didn't exactly "fail" in the sense of now it's being forced to raise capital / broken up / burned to the ground. Instead it failed assuming it follows the capital plan it submitted to the Fed, which is clearly a capital-lowering rather than capital-raising plan. I ballpark it at $10bn of share repurchases and dividends,* which is ... well, it's pretty big for Citi. So they can just not do that then. Or not do quite as much of that, which seems to be their plan: In light of the Federal Reserve’s actions, Citi will submit a revised Capital Plan to the Federal Reserve later this year, as required by the applicable regulations. The Federal Reserve advised Citi that it has no objection to our continuing the existing dividend levels on our preferred stock and our common stock, and we plan to do so, subject to approval by the Board of Directors each quarter. The Federal Reserve also advised that it has no objection to Citi redeeming certain series of outstanding trust preferred securities, as Citi proposed in its Capital Plan. We plan to engage further with the Federal Reserve to understand their new stress loss models. We strongly encourage the public release of these models and the associated benchmarks and assumptions. We believe greater transparency in this process will best serve all banking institutions and their shareholders as well as the international regulatory community and market participants, and will encourage a level playing field globally. There are at least two ha! moments in that snotty last paragraph. First there's the fact that the Fed had planned to release the stress test results on Thursday and got gun-jumped by Jamie Dimon. So much for Fed transparency. But also, specifically, as people are all running around suing each other about the Fed maybe kind of encouraging bank CEOs to hide material information from investors, it is odd that the Fed would have the stress test results and sit on them for two days. Imagine the scenario where Jamie Dimon, Vikram Pandit, and the Fed all know that JPM passed and was going to do a largeish buyback, while Citi failed and was going to do a ... I guess somewhat smaller buyback - and they didn't tell anyone from today until Thursday. If you sold JPM to buy C today, wouldn't you be kind of annoyed?**