Economic forecasts in bank tests miss their mark

AP News
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Posted: Nov 09, 2009 7:05 PM

All but one of the 19 largest banks have raised the extra capital cushion regulators said they'd need to withstand a deeper recession _ a sign, the Treasury secretary said, of how much the financial system has improved since the crisis began.

But the banks' capital needs were based on unrealistic economic projections. Some have proved too rosy, others too grim.

For example, the test envisioned unemployment reaching 8.9 percent this year; it stands at 10.2 percent.

On the other hand, the tests assumed housing prices would fall 22 percent this year in a worst-case scenario. Instead, they fell 5.5 percent in the first half of the year and have risen for the past three months.

Earlier this year, the Obama administration subjected the 19 largest banks to "stress tests." The goal was to boost confidence in the financial sector by showing how strong banks' balance sheets were. Regulators used a series of economic projections to see if banks could withstand the losses they would suffer in case of a deeper-than-expected recession.

But the recession diverged far from the economic projections used. Analysts say their results reveal little about what troubles the banks now face. Though conditions have improved since the depths of the credit crisis, some analysts say certain banks face problems the stress-test buffers may not solve.

"We're already at record numbers on losses, and those numbers are rising," said Christopher Whalen, managing director of Institutional Risk Analytics.

The test results in May found that 10 of the 19 largest banks needed more capital to withstand losses they would suffer if the recession worsened. They were given six months to raise a total of $74.6 billion of capital. The Federal Reserve said Monday that they have raised a total of $77 billion.

Whalen said that if the banks approach the loss rates the stress tests envisioned, they still might not have enough capital to stay afloat.

The only bank that failed to raise the required capital was GMAC, which is weighed down by bad mortgage loans but provides financing to auto dealers and buyers. Regulators had said GMAC needed to raise an additional $11.5 billion.

The company is in talks with the Treasury Department about getting a fresh bailout from the $700 billion financial rescue fund. It is unclear how much money it will require. But Secretary Timothy Geithner said it "is expected to be lower than anticipated" when the stress test results were announced.

GMAC already has received $12.5 billion of taxpayer money. The Detroit-based lender is in "active dialogue" with Treasury about its next round of bailout money, said spokeswoman Gina Proia. Those funds will be used to fulfill the stress test requirement "and not to resolve any new matter related to our business," she added.

GMAC provides wholesale financing to many General Motors and Chrysler dealerships to pay for the vehicles on their lots. The company also operates a mortgage lending unit _ Residential Capital _ which has been pummeled by the housing market downturn. It runs an insurance unit and an online banking unit called Ally Bank.

Geithner said the success of the other 18 companies showed that the financial sector has become far more stable since January.

"Banks are repaying the taxpayers with interest and credit is coming back, but we need to reinforce that improvement and ensure that small and medium sized businesses can borrow to create jobs," he said in a statement.

Whalen said that despite government subsidies, banks like GMAC and Citigroup Inc. still are too troubled to extend credit and support an economic recovery.

"These are zombies and they can't make loans," he said. "None of this is helping the real economy."

Whalen said the only way to improve the companies would be to push them into bankruptcy and get rid of the bad assets that are weighing them down.

GMAC could not raise money in part because investors needed to charge high interest rates to offset the risk that the company could fail.

The nine other banks, including Bank of America Corp., Wells Fargo & Co. and Citigroup, raised the money from private investors, by selling assets or by converting preferred equity into common shares.

GMAC was previously owned by General Motors Corp. GM later sold a majority stake and GMAC spread its lending into other areas, such as home mortgages.

Like most financial companies, GMAC struggled to find financing when the credit markets seized up. Its bonds are rated at junk status by major ratings agencies, further complicating its ability to raise new funds. GMAC recently used a Federal Deposit Insurance Corp. program to help it issue debt backed by the government's top rating.

Analysts have suggested that a further infusion of government aid could help improve GMAC's financial stability. But it remains dependent on a broader economic recovery in some of its key markets, like autos, Moody's Investors Service analyst Mark Wasden wrote in a credit research note last week.

"GMAC's ratings will be constrained as long as recovery in the auto industry remains elusive," Wasden said.

The stress tests subjected banks' balance sheets to two economic scenarios. One was meant to look like the recession and recovery analysts expected. The second was envisioned as a much worse recession.

Banks were told to raise enough money to withstand the losses they would see under the harsher scenario.

Some analysts have criticized the additional bailout as an equity investment in an otherwise insolvent company. GMAC's bailouts have come from Treasury's automaker rescue program, rather than from the pool of money designated to shore up healthy banks.

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AP Business Writers Martin Crutsinger in Washington and J.W. Elphinstone in New York contributed to this report.