Last updated: May 6, 2009 11:48 pm

Bank stress tests

The priority was to calm panicked markets

It’s oddly masochistic to be so looking forward to something called a “stress test”. While the anticipation has been universal, however, few agree on what Thursday’s results will achieve – or even whether the tests were a good idea in the first place. The debate is muddled because the main protagonists have completely differing expectations.

Take the US government first. The Treasury can arguably be pleased with the process, whatever the results. Its priority was to calm panicked markets. This it did. Beyond that, Tim Geithner cares little for shareholders. The Treasury secretary views the banks’ role as lenders to the wider economy. That is why he has no intention of letting them rush to repay public money. His priority is to ensure credit flows again – toxic assets can be a future administration’s problem.

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What about the banks themselves? In the short term, they will manage their balance sheets to whatever arbitrary level of capital adequacy is now deemed appropriate. Citigroup, for example, could be on the hook for about $6bn, although some reckon it really needs $40bn. The more governments have to backstop private capital raising over the next six months, the greater their influence over what concerns bankers most: pay. Escaping the clutches of a populist administration will be the primary focus for banks in the coming years.

Finally, shareholders. In the short term, many will be diluted as preferred shares are converted into common equity but at the end of this process many will be convinced the banks have been restored to health. The new equity may look superficially cheap: the issuing banks will, after all, be forced sellers. Longer term, however, the $3,000bn-odd aggregate hole in US financial sector balance sheets is beyond the private sector’s ability to fill. Mirroring Japan more than a decade ago, Thursday may well mark less of the revival of the sector than the beginning of zombie banking in America.

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