Orbital Matters

Saturn Smith
Editor’s Pick
FEBRUARY 24, 2009 12:50AM

Wall Street Stresses Me Out

Rate: 17 Flag

I'm not a high-stress person, most of the time.  I have a pretty easy life of eating cupcakes and blogging -- OK, that's not completely true (¿dónde están mis cupcakes?1), but here's what I think is an accurate graph of my stress:

The more I know (after that initial blast of ignorant bliss) on any situation, generally the less stressful I find it.  Theoretically, in any given situation, I could reach a point where I know so much about the situation that it wouldn't add to my stress at all to be in that situation: driving, for instance, would be a great example of this.  When I started driving, it was scary -- now it's just a natural part of the day.

Apparently, the government feels the same way, because they're instituting this week stress tests on the 20 major national banks, in order to find out exactly how screwed we all are.

So what does a stress test look like for a bank?  Though I have a (rather pleasing) image of all the CEOs being forced to run on treadmills under physician supervision, it's actually a numbers game -- in fact, it's most similar to a War Game, if you want to think in usual government terms.  The New York Times kindly explains:

The stress tests will use computer-run “what if” situations to estimate what would happen to each bank under Depression-like conditions, with unemployment surging to 10 or 12 percent, for example, or home prices dropping 20 percent further, Treasury and Federal Reserve officials said.

Fed officials emphasized that these hypothetical events were “highly unlikely” to occur.

By the way, if you're wondering -- everyone expects several of these banks to fail the tests.  And if that last line seems un-reassuring, well, hey, when has the Fed been wrong before?  Oh yeah.

Is your stress line going up?  Mine is.

So, since the Fed's playing with hypotheticals, I thought I'd join in: What happens if these banks fail the stress tests?
  1. Someone leaks news of their failure to, I don't know, CNBC, if they can get through what with all of Rick Santelli's fans clogging the phone lines.
  2. The markets hear about it and go, "OH NO!" except probably with a sterner vocabulary.
  3. The markets tank.  (I'd draw you a graph, but you could just go check out the Dow today).
  4. Mass hysteria, depression, etc.
There's an option 3.5, but it involves that word that's so strenuously avoided: nationalization.

Oh no!  Nationalization!  Pass the cupcakes, quick, before the Politburo outlaws them!

Here's the thing: No one is actually talking about real nationalization.  No one, not even my so-left-he-voted-no-on-the-Stimulus Congressman, is advocating complete, permanent government take-over of the banks.  What is being suggested is receivership, which is actually a well-established tenet of the free market system and American bankruptcy in particular2.  A business fails, and instead of having to liquidate its assets, a receiver is appointed to take over management of the business.  With smaller banks -- like those that failed last week, for instance -- usually the FDIC, as appointed receiver, approves a take-over by some other bank, and there's little disruption for customers or even the market in general.

Now, I'm going to assume that your average Wall Street trader knows the difference between nationalization and receivership.  So why is this so scary?  What's the hang up?  Well, it turns out, when a bank goes into receivership, two things happen:
  1. Management is replaced.
  2. Shareholders have the lowest priority for claims on any assets held by the group -- essentially, they lose their money.

So people -- traders and shareholders alike -- freak out on mention of nationalization, and even receivership, for good reason: they stand to lose substantially.  Or, I guess, more substantially, because shares of Citigroup (as an example) have tanked recently, and closed today worth something like $2 (a year ago: $24; two years ago: $54). 

The Catch-22 of this situation is this: if people hear that the government is about to take Citigroup into receivership, they sell their shares frantically, which reduces shareholder confidence even further, which makes it more likely that it will fail the stress tests, making it more likely that the government will need to take it over.

This is all based upon a lot of unknowns: what are the specific tests the Treasury and Fed will be giving?  How will the banks do?  What will happen next?

I would love to see those questions answered in President Obama's address tomorrow night, but it turns out that Wall Street bankers in general have an opposite stress graph to mine: they love ignorance, because it somehow gives them hope.

So here's what we do know, or should know: receivership is going to hurt.  It's not a perfect option.  (Please: give me an example, short of physical burning of their paper money, that doesn't end with significant loss for investors).  But it offers the least risk to the most people, and even a chance for taxpayers to get some payment back, should dramatically altered management actually improve the status of these banks.

Today, rumors circulated that the government is going to convert its 8 percent stake in Citigroup Preferred stock to common stock, furthering diluting the value of those shares and giving the government about 40 percent "ownership" in Citi.  This is meant to avoid the "nationalization" option.

What I'd like to know is, why?  Why fight this?  What exactly are we waiting for?  (GOP friends -- don't bother answering that question, because I know you're waiting on tax cuts to fix this, just as you're waiting on tax cuts to solve the problem of forgetting your mother's birthday).

We need action.  Receivership is the closest we can come, as taxpayers and as participants in the system, to having our cupcakes and eating them, too.  (What can I say?  Stress makes me hungry).

I hope we hear more about this tomorrow.

1 I have a friend who bakes when she's stressed. I hope she's reading this. I really would like a cupcake. [Return to Post]

2 The most famous current case of receivership, by the way, isn't a bank: it's Britney Spears, whose father has conservatorship over her and her accounts.  I think there's a way to make a direct comparison between that situation and the current banking crisis, and even started a post called "Britney Spears is Too Big To Fail," but it actually seems mean to Britney Spears to compare her to most of the major bank CEO's.  If I get over that feeling, I reserve the right to recall that title. [Return to Post]

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I'm starting to think a better investment of stimulus dollars would have been in the making, distribution, and consumption of cupcakes. Creates jobs and makes everyone happy.

Though in the interim -- Yes! Eclairs! You're speaking my language.

I'm very intrigued by the Buffet book. I have Krugman's "Depression Economics" on my bedside shelf right now. They'd probably be fast book friends.
Nationalism is a dainty word for socialism.

Personally, I'm looking for a calorie free, gluten and casien free jelly donut that doesn't contain xanthan gum.

It's bad enough I can't eat... now I have to deal with the stress of watching my homeland and my entire way of life turn into a socialistic nightmare while everybody around me kneels and prays to Washington DC (in the east) in the hope that Obama is actually a Saint and not a mere President.

Did you say you have cupcakes?
Got any wine to go with that?
Yeah, I don't agree about nationalism being akin to socialism, Pink Berry. But I'm certainly willing to share cupcakes, when I next find them.
let's talk stress - I'm 50 and have lost 12 years worth of retirement savings at least. since we no longer have pensions, what many of us have for retirement is our 401k's etc. well, that's what we did have.
There's never a good time to take a hit like that in the market, but there are certainly some very, very bad times, and I'm so sorry your're so near one of them. That is some serious stress.
The little ape here is still grounded from tracking the market from his cell phone (he cheats and looks, I've seen him).

On the up side though, is the fact that people are now appreciating cute and tasty things more. I should make a ling thingie about that.
The market continues its cliff diving because everybody is wanting to know which banks will fail. Not if, but which. Look, these banks (and the credit card companies they own) made a killing recently selling debt as if it was a commodity. DEBT. The sales side of the banks made as many loans as it could (mortgages, credit cards, loans for important things like cruises, loans to consolidate one’s debt, etc.). The service side of the banks packaged these loans (DEBT) together and then sold them to brokerage firms so that sucker s like me could actually buy a share of my own debt.

Last year you could sell $100.00 of debt for $115.00. The buyer of the debt was counting on people not being able to pay their loans off on time (e.g., pay interest only) or on being late and then accruing those extra (and steep) late fees. The more loans to those who really couldn’t afford it, the more profit for the holder of the debt. In essence, a Ponzi type process where the last in get screwed. Today you can buy $100.00 of debt for $100.00, so nobody wants to do this anymore, but the debt still exists.

The best thing the Obama administration can do is to act swiftly, take over these banks in the short –run, fire the management, cut their losses and let the market find its equilibrium. The DJ will rise as soon as the “bad” banks are named and put out of their misery.

And on a side note, I can’t wait to hear Bobby Jindal’s retort tonight. Here’s an over-valued governor of one of the poorest states in the Union: saying no to stimulus dollars so he can build up his conservative bona fides at the expense of his already hurting constituency. Brilliant Bobby. Just Brilliant!!

I’m going to get a cupcake myself.
Excellent post as always, but I must point out one error. The price of a bank's common stock does not effect its capital position, which is broadly defined as assets (mostly loans outstanding) minus liabilities (mostly deposits). The ratio is not affected by whether the stock is $2 or $20. However, the price of the stock affects profoundly the psychology around the company. A plunging stock price makes it far more likely that the bank will not be able to raise additional funds through stock offerings on its own. Academic studies have shown that stocks that fall from double digits in price to below $5 a share typically go to zero.

Sayonara, auto makers. Arrivederci, most money-center banks.

I agree with you that receivership, as opposed to the government stupidly converting preferred stock to a worthless common stock, is the least of all evils. I've blogged several times that what the bailout is lacking is a systemic change to the behavior that created the problems in the first place. Direct government presence on the boards of these banks is imperative. In all likelihood, canning the entire senior management of them is also a necessary step to altering the courses they're on. I believe there are plenty of talented, honest people in the wings to replace the Ken Lewis's of this mess.

What amazes me is that we haven't had a good ol' fashion run on these major banks yet. I think the government secretly fears this scenario the most; receivership now would at least prevent that kind of panic. There wouldn't be enough George Baileys to save us if that got started on a massive scale.

I eat when I'm stressed, too. I've gained 10 pounds since Christmas. Your post is NOT helping my waistline. Speaking of which, check out my recent post called "Twinkies, It's What's for Dinner."
So much for Greenspan's corporate "self-regulation." We need to start thinking outside the box.

You realize that, money is not real? It seems real because we agree on it, and the banks want it from us and from the government. And in this society, we have to have it to live. But in the end, it is an agreed on method of barter that is paper printed by the FED, which actually is a private banking clearinghouse rather than strictly government. It is not the only method of exchange. It is legal to print our own money, as long as it is not an imitation of the government money. That little fact surprised me.

We do need to jump-start our own local economies.

Perhaps the entire banking system is fatally flawed. What if in the near future, wealth has nothing to do with money, but has to do with access to natural resources like healthy soil, clean water, organic, non-polluted food, clean renewable power, and home-based health care? And, all this must be done locally in order for it to be reliable.

Can it be done? Yes, unequivocally. Check out any website with the word "permaculture." This concept was created in the seventies (I think) by an Australian, Mollison, and has been put in practice at localities all over the world. It is a set of principals and actions that create a harmony between nature and man, so that man imitates nature rather than "conquers" nature. It's principals are socially as well as environmentally sustainable, and can be applied to urban, suburban, as well as rural settings. One of the sayings of permaculture is, "Do what you can where you are." Basically, it is good to make a start on sustainability, and don't worry about everyone else. They will change when the scarcity and the pain of environmental degradation become too much to handle.

Thanks for educating people on our economic meltdown. But it is not just a matter of money. When people understand what's really happening, they will be able to make wiser choices that will both improve our Earth, and possibly save the human race.

And I just made some really healthy and good organic oatmeal walnut cookies...

Books? Live Well on Less Than You Think, by Fred Brock, Hot flat and Crowded, by Thomas Friedman, Colapse by Jared Diamond, Garden Planet by Wm Kotke, I really like Buffet, too!
Thanks, Saturn, for making this so easy to understand, and to everyone else for your comments, both culinary and otherwise.

I feel like I've had a short prep before tonight's speech. If only I could find some decent wheat&dairy-free cupcakes. (I'd even be willing to put up with the xanthan gum.) However, I do have some cinnamon buns that will work. Courtesy of Kinnikinnick (GFCF).

Personally, I'm looking for a calorie free, gluten and casien free jelly donut that doesn't contain xanthan gum.
Ooops! ...sloppy editing. mea culpa.
"(GOP friends -- don't bother answering that question, because I know you're waiting on tax cuts to fix this, just as you're waiting on tax cuts to solve the problem of forgetting your mother's birthday)."

Gosh, you make me laugh. In the unlikeliest places!
1. Frankly, I think Britney Spears IS too big to fail (and that says a lot about us as a People). And I don't feel that way about any bank.


2. "...it's actually a numbers game -- in fact, it's most similar to a War Game...."

Hey, I get Irkutsk!
There are measures short of receivership that the FDIC can take for weak banks, such as requiring them to raise additional capital, limiting asset growth, limiting dividends, that don't compound the problem of what to do when too many bad assets hit the market at the same time and there aren't enough buyers. At one point in the 80's all large banks but one (State Street) in Boston were under FDIC regulatory agreements, but only one (Bank of New England) went into actual receivership. A buyer was found for BNE (Fleet), and the remaining banks recovered. If all banks in a market are put in receivership on a blunt-instrument basis, it is unlikely sufficient buyers would be found, increasing losses to you and me--so selectivity is a good thing. The FDIC doesn't have the manpower or the expertise to handle that type of scale anyway. By the way, we are still running far behind the bank failure rate of the 1980's, which is one reason to remain relatively calm. The headlines have come bigger and faster this time because the failures and conversions have occurred at the big investment banks, not the small and medium commercial or savings banks. Thus, what was a slow drip in the 80's (many banks holding individual bad mortgages) has been a wave this time (few banks holding packages of many bad mortgages).
i wish that obama would get up tonight and say this:

"we're going to do this receivership thing because these banks screwed up and lost a lot of money. we can't keep throwing money at them because it's not fair. we can stabilize the banks by paying too much for their assets (since the assets are actually worth -200 dollars at this point), or we can pay them what their assets are worth and the bank would still fail (see above statement about being worth -200 dollars). receivership means that the people who own shares in this bank won't get paid. they get very sad about this, so the stock prices will go down as they try to get rid of their stock. i know this can be scary, but it's ok. we're gonna do this receivership thing, the market might be sad about it for a little while, but it's the only logical choice that protects the taxpayers and gets us on track."

then i want him to take questions where he explains every piece of that statement.

a girl can dream can't she :)
since getting the economy back to normal means re-creating the conditions that led to the latest collapse, i suggest the american ruling class has entered a terminal phase, characterized by slogans such as "apres moi, le deluge!"

the really scary bit is, all the rest of america nods their head saying "all together now!" as they trundle down the ramp to the killing hammer.

people, american banks have been recently stress-tested. the results are all around you, on the ground. perhaps if you opened your eyes and looked backwards, just for a change....?
I recommend to everyone the writings of William K. Black. The financial industry and the government are currently mired in trying to figure out how to avoid coming completely clean to the public on the extent of the banking system insolvency. It could cause a general and out-of-control rapid downward-spiral panic. My next blog post will deal in some detail on the topic.
James Poyner, good grief, of course, you're right -- I made that circle completely wrong and have fixed it. Argh. Thanks for the informed comment!