Latest / Bloomberg Intelligence / Kroll's Whalen Sees Fed's Bank Stress Tests as Miguided (Audio)

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Kroll's Whalen Sees Fed's Bank Stress Tests as Miguided (Audio) · Bloomberg Intelligence

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  Speaker 1: Charlie Pellett and that's Subloomberg Business Flash. You're listening to
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  Speaker 1: taking Stock with Pim Box and Kathleen Hayes on Bloomberg Radio.
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  Speaker 1: It's past failed. But the feder Reserves stress test either
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  Speaker 1: you have enough capital with standished severe economic shock or
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  Speaker 1: you don't. That's why we're gonna dive now into the
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  Speaker 1: results on the latest dress test just announced by the
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  Speaker 1: Federal Reserve with a man who is known for his
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  Speaker 1: top down and bottom up look at big banks, their
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  Speaker 1: balance sheets and more. Chris Wayland, senior Managing director at
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  Speaker 1: the Kroll Bond Rating Agency here in New York City,
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  Speaker 1: joins us. Now, Chris, welcome back, Good afternoon, Kathleen. So
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  Speaker 1: everybody passed, though Morgan Stanley trailed the rest of Wall
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  Speaker 1: Street in a key measure of leverage. What do you
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  Speaker 1: see in these results? Well, it's hard to say that
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  Speaker 1: FED doesn't give us enough information to really assess the
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  Speaker 1: tests in a, you know, in an objective sort of way.
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  Speaker 1: It's good that they all passed because of the obvious cost.
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  Speaker 1: You know, if you fail, you're not allowed to return
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  Speaker 1: money to shareholders, You're not allowed to pay the dividends
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  Speaker 1: you want. So it has a big impact on the
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  Speaker 1: equity markets. UM. And really, as we've discussed in the past, Kathleen,
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  Speaker 1: you know, bank stress is not about capital. It's about liquidity.
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  Speaker 1: That's why we had the crisis, and so these tests
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  Speaker 1: are kind of to make us all feel good. But
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  Speaker 1: does a bank ever consume capital before it fails. No,
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  Speaker 1: So the whole premise of the test is I think
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  Speaker 1: a bit misguided. And it goes back to you know,
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  Speaker 1: Secretary A. Geitner when he first came up with the
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  Speaker 1: idea of stress tests as a way of restoring confidence
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  Speaker 1: in banks, UM, it had an obvious political uh utility.
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  Speaker 1: But the continuing stress tests that we go through each year,
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  Speaker 1: you know, frankly or enormous drain on banks. The senior
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  Speaker 1: management has to spend months modeling economic scenarios and a
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  Speaker 1: lot of stuff that has nothing to do with running
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  Speaker 1: the bank. Uh. And so when you look at these results,
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  Speaker 1: you really don't know what to say because the FED
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  Speaker 1: doesn't give us enough information to understand the tests. And
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  Speaker 1: in particular, you know, true question about Morgan Stanley to
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  Speaker 1: understand just why it is that they did less well
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  Speaker 1: than the others, you know, since they all passed, right,
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  Speaker 1: Chris Whalen has the Federal Reserve in following the Dodd
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  Speaker 1: Frank legislation, Have they created this whole other industry within
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  Speaker 1: banks that has nothing to do with the banking industry,
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  Speaker 1: where the functions that they provide to their customers or
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  Speaker 1: their clients. Well, it's certainly a big cost. I mean,
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  Speaker 1: it is a lot of additional cost for banks which
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  Speaker 1: comes out of the pockets of shareholders. And yes, I
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  Speaker 1: agree with the way you characterize. It really has nothing
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  Speaker 1: to do with running the bank. I often asked the
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  Speaker 1: banks that we rate, who's running the bank while you
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  Speaker 1: work on the stress test, because it's just it's board members,
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  Speaker 1: senior management and lots of consultants. Well, a way is
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  Speaker 1: a heart. I'm looking at our Bloomberg's story by Jesse
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  Speaker 1: Hamilton's and Dacan Campbell, and it looks at systemically important bank.
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  Speaker 1: So that's well as far will be of a JP Morgan, Goldman, Morgan, Stanley,
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  Speaker 1: City State and Bank of New York melot and the
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  Speaker 1: regulatory minimum, for example, for a common equity Tier one
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  Speaker 1: capital ratio is four and a half percent, and then
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  Speaker 1: it shows what the capital ratios are. Wouldn't be pretty
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  Speaker 1: easy if you're a big bank to say, oh, here's
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  Speaker 1: my capital ratio. Boom if I'm above four and a
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  Speaker 1: half percent, am okay, right. But you and I could
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  Speaker 1: do a very thorough stress test, Kathleen with the public
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  Speaker 1: data in half an hour. We wouldn't need to come
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  Speaker 1: up with economic scenarios. We wouldn't have to employ economists
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  Speaker 1: and other consultants to work on this for months. Stress
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  Speaker 1: testing is about loss absorption. That's all it is. But
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  Speaker 1: you know, if you think about it, when a bank fails,
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  Speaker 1: the only thing that capital really does is offset losses
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  Speaker 1: to the industry, because the industry ultimately backs up one another,
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  Speaker 1: joint in severally. That's what the fdi C is. It's
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  Speaker 1: a big mutual insurance company and the industry stands behind it.
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  Speaker 1: So only if a bank fails do we care about capital.
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  Speaker 1: What really matters if the bank is a going concern
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  Speaker 1: is liquidity and access to markets and confidence with a
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  Speaker 1: capital C that's all it matters. If you don't have confidence,
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  Speaker 1: no amount of capital will save you. Chris is part
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  Speaker 1: of this confidence building exercise. I understand that banks had
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  Speaker 1: to project greater losses than in previous stress tests, including
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  Speaker 1: what about a hundred and thirteen billion dollars in trading
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  Speaker 1: losses for that that was for the eight largest firms, right, Yes,
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  Speaker 1: how did they come up with that number? They're doing
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  Speaker 1: is they're trying to throw a severe scenario at the
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  Speaker 1: bank and say could you get through such a scenario
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  Speaker 1: and still have capital left? Um, we do very similar
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  Speaker 1: sorts of tests on banks when we rate them. We
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  Speaker 1: look at a moderate scenario and then we look at
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  Speaker 1: the crisis and say, how did you do through the crisis?
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  Speaker 1: Because that was a big spike in losses. It was
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  Speaker 1: enormous for three s four standard deviations. So you know,
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  Speaker 1: it's all fine, but it doesn't really tell me as
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  Speaker 1: an analyst whether or not a given bank is going
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  Speaker 1: to be able to do well in a time when
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  Speaker 1: investors get cold feet and run, which is what happened
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  Speaker 1: in in in two thousand and eight. And again remember,
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  Speaker 1: but it's all about liquidity, it's not about capital. Uh.
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  Speaker 1: And with all due respect to my colleagues in the
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  Speaker 1: FED and everywhere else, um, you know, capital has become
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  Speaker 1: the panacea it's the thing we all grab onto and say,
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  Speaker 1: oh good, the banks are safer, But really, market liquidity
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  Speaker 1: hasn't recovered. And I think what the FED is doing here,
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  Speaker 1: PIM is they're kind of talking their book because with
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  Speaker 1: monetary policy, we've distorted markets, We've distorted credit spreads, and
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  Speaker 1: I think the FED is a little worried that once
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  Speaker 1: we start to see rates go up, you're going to
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  Speaker 1: see a lot more volatility. Well, now the Feds talking
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  Speaker 1: it's books, but the stress tests are the outcome of
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  Speaker 1: the Dodd Frank regulation passed by Congress pick Kathleen the focus.
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  Speaker 1: You know, PIM was just talking about trading losses, big concern.
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  Speaker 1: I'm much more worried about a lack of revenue for
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  Speaker 1: banks from trading. Frankly, yeah, you know, and I get that.
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  Speaker 1: I mean, there's a lot of still a lot of
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  Speaker 1: controversy over the vocal rule and everything. But it seems
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  Speaker 1: to me that the you know, the FED is sort
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  Speaker 1: of just going along with what Congress wanted to see,
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  Speaker 1: which was something, uh, something more really hitting at the banks.
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  Speaker 1: And anytime you turn on the news, Boomberg Radio, Bloomberg television,
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  Speaker 1: any Bloomberg outlets read the stories. Someone in Congress is saying, well, well,
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  Speaker 1: one of two things. Some are saying you're not strict enough,
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  Speaker 1: and that's gonna be a big issue in the campaign.
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  Speaker 1: The presidential campaign of thos are saying you're too tough. Well, look,
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  Speaker 1: you know, the good news is American banks are very
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  Speaker 1: well capitalized compared to banks around the world. Do they
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  Speaker 1: have enough capital? It's hard to say, But what I
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  Speaker 1: can tell you is that the approach of regulators is
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  Speaker 1: basically to punish the victims, particularly the shareholders, and hope
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  Speaker 1: that by punishing the victims, they're going to change the
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  Speaker 1: behavior of the banks. But we're not punishing the people
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  Speaker 1: who caused the crisis. We've already said we won't do that.
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  Speaker 1: So it's a very strange approach. You know, you punish
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  Speaker 1: everyone but the guilty, and you hope that the innocent
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  Speaker 1: they're going to prevent them for being bad in the future. Okay,
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  Speaker 1: that's that's a very indirect way of approaching the problem. Right. Well,
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  Speaker 1: here's something perhaps even more indirect, if that's possible. Next week,
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  Speaker 1: the Federal Reserve will announce the institutions that asked or
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  Speaker 1: failed the qualitative part of their exams and haven't the
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  Speaker 1: banks complained that the qualitative portion tends to be subjective?
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  Speaker 1: Is it subjective? You're you're assessing management, you're assessing internal systems,
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  Speaker 1: You're you're trying to discern whether they have good risk management,
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  Speaker 1: does management know what risks they're taking? These are qualitative issues,
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  Speaker 1: and they're very similar to what we look at in
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  Speaker 1: the ratings world. We have the quantitative stuff, the numbers,
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  Speaker 1: and the qualitative parts of the most difficult to judge
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  Speaker 1: because you're ultimately looking to see whether or not the organization,
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  Speaker 1: the people, the systems can prevent risks. And that's that's
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  Speaker 1: the tough part. Well, then, uh, let's step back big picture,
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  Speaker 1: depending on whoen's the White House and the congressional races. Um,
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  Speaker 1: any chance someone would say, you know what, this is
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  Speaker 1: just too much work. Why don't we just make it
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  Speaker 1: clear to banks that if they don't have enough capital
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  Speaker 1: and they don't really listen to their risk management officers
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  Speaker 1: and they get in trouble, we are just going to
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  Speaker 1: quickly resolve them and do it that way. Would that
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  Speaker 1: put the fear of you know, financial regulator, that you know,
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  Speaker 1: the fear of the market into them, and you would
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  Speaker 1: need all this stuff, well, I suppose I think a
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  Speaker 1: better way, Kathleen would be to force in the raise
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  Speaker 1: more capital, and that's what we're doing now. Do away
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  Speaker 1: with the stress test and simply rely on public data
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  Speaker 1: the investors can look at and understand. And then I
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  Speaker 1: think put a lot more emphasis on confidence, on avoiding fraud,
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  Speaker 1: on avoiding types of events and missteps that cause investors
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  Speaker 1: to lose confidence. Because when investors run away from a bank,
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  Speaker 1: when they no longer will face a Lehman or a
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  Speaker 1: Bear or whomever, right that that that institution can't function,
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  Speaker 1: doesn't matter how much capital they have. It really doesn't.
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  Speaker 1: At the end of the day, they have to have
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  Speaker 1: access to the market, so it's about liquidity. Thank you
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  Speaker 1: very much for joining us. Chris Whalen is senior managing
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  Speaker 1: director at the prole Bond Rating Agency and the polls
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  Speaker 1: and we will be covering it next. You're listening to
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