Thursday, May 7, 2009



This may be one of the more naïve questions arising out of the bank stress tests, the purpose of which still puzzles me, but here goes: What does converting preferred stock to common stock, or conventional preferred stock into these newfangled mandatory convertible preferred shares accomplish for a bank’s primary capital? I’m no expert in bank accounting or bank regulation, but aren’t common stock and preferred stock both considered primary capital? And if not, why not? Both stand behind, and thus, in a sense, “support” deposits and other forms of bank indebtedness.

One could argue that exchanging preferred for common helps shore up capital by removing the drain on retained earnings caused by payment of preferred dividends, but a bank, or any corporation, can suspend preferred dividends without converting the preferred into common.

Just what is getting accomplished by such conversions? This is more than another example of my customary ornery objection to the conventional wisdom; I really want to hear from any banking experts out there with an answer to that question.

There are numerous other questions arising from the much ballyhooed stress tests, like:

--What did they accomplish, other than reversing the government’s former policy of treating all banks alike in favor of separating the wheat from the chaff? The former was misguided, the latter makes sense, but it is the market, not the government, that should be making such distinctions.

--Were the downside scenarios used in the stress sufficiently severe? Loyal readers don’t need to guess as to what I think here: Of course not. The “experts,” who are insisting that what we are experiencing is a somewhat more severe version of a normal, garden variety recession that should be ending any day now have not lived long enough to realize that the way we have been conducting ourselves financially for the last twenty or so years has laid the groundwork for a grinding, backbreaking depression that will take many years to work its ameliorative magic, and that’s my OPTIMISTIC scenario.

One more thing…you might want to make a note of the banks and other financial institutions the governments have deemed, if not good, in no further need of capital, just so we can all share a hearty, if misanthropic, laugh when they go down the tubes, or come begging for more of your dough, in the relatively near future:

American Express (Yeah, that credit card business is just terrific, eh?)
Bank of New York Mellon
Capital One Financial (See my parenthetical comment re Amex)
Goldman Sachs
JP Morgan Chase (See my parenthetical comment re Capital One)
MetLife (Yeah, those variable annuity contracts and other guaranteed contracts are going to work out just fine.)


Brian said...

That is a great questions I too will try to find the answer. I was not aware banks could defer those dividends. Smoke and Mirrors it seems

The strange thing about the stress tests is that they were designed when the govt thought they were needed to build optimism. Little did they know optimism would be bubbling over by the time they released the "results." How does the saying go, "the bigger they are, the bigger the fall?"

Psychologically, it seems like the market has been fighting a pullback so strongly that the first sign of actual trouble will see much $ lost. We've seen 5 years worth of gains in 50 days

Unless all the TAs out there calling this a Inverse Head and Shoulders *are* right, the bear market will have the last laugh!

The Pontificator said...

Thanks, Brian. I certainly don't disagree.