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Fallout: The Financial Crisis

Investors brace for stress test results

Amy Scott May 6, 2009
Fallout: The Financial Crisis

Investors brace for stress test results

Amy Scott May 6, 2009


Kai Ryssdal: More than anything else today the leak of those stress test results has been greeted with relief. That now, finally, the market has a better picture of how the banking industry’s going to get fixed. But it has been three months that the government’s been working on those tests. Three months during which the market hasn’t really had that much information. Our New York bureau chief Amy Scott reports.

AMY SCOTT: Walter Todd invests money for institutions and wealthy families at Greenwood Capital in Greenwood, S.C. When I got him on the phone yesterday, he was about to sell some Bank of America stock in case of bad news.

WALTER TODD: We’re kind of hedging our bets a little bit. We’ll still have plenty of exposure if things go well. But at the same time, taking a little bit off the table ahead of these results. ‘Cause the fear of the unknown is the biggest thing for us.

Even when the official results come out, some question how much investors will really learn. Frank Partnoy teaches securities law at UC San Diego.

FRANK PARTNOY: The problem with the stress tests is twofold: they’re not stressful, and they’re not tests.

You’ve heard the metaphor. A doctor tests your heart by putting you on a treadmill and sets it at an incline to make things challenging. So examiners checked how banks would hold up if the economic road gets steeper. Only Partnoy says the Fed didn’t apply a worst-case scenario. It assumed unemployment and economic growth wouldn’t get too much worse.

PARTNOY: The problem with that metaphor with these stress tests is that the treadmill is now at zero degrees. We thought initially it would be hard to run on this treadmill. But now it’s easy.

Officials relied on the banks’ own assessment of some of their troubled assets. Partnoy says it’s a bit like the doc taking off the electrodes, ignoring the data and asking, how do you feel?

PERSON ON TREADMILL: I feel pretty good.

If Bank of America really needs to raise $34 billion, it’s not feeling great. That could be bad news for everyday investors whose pension funds and 401k’s often include financial stocks. Dave Ellison is chief financial officer at mutual fund company FBR Fund Advisers. He says regulators should have been doing these stress tests all along.

DAVE ELLISON: It’s almost as if everybody had this collective brain cramp around the world that we didn’t need to do any regulation, that capitalism should be free for everybody, and now we’re realizing we need to regulate. Capitalism is free, but sometimes you need to put it on a leash.

Ellison invests in bank stocks, so he’s hoping they’ll stage a recovery, like they did after the banking crisis of the late 1980s.

ELLISON: The best time to buy financial stocks in my career was from 1990-1997. I had stocks that went up eight, 10, 50 fold. Because we went from an incredibly ugly period to a much better period driven by better regulatory review and better managements, and the same thing is happening today.

Ellison is not predicting the same kind of stock returns now. And it could be a long time before the banks get back on their feet. The stress tests covered just the 19 biggest banks. Matthew Anderson is with Foresight Analytics. He keeps a watch list of banks with worrisome levels of bad loans or not enough cash on hand.

MATTHEW ANDERSON: In the fourth quarter we had 276 banks on our list. We don’t have all the data yet for all the banks in the first quarter, but we’re estimating that that figure will rise to about 375.

Anderson predicts many of those banks will fail.

In New York, I’m Amy Scott for Marketplace.

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