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Banks Can Handle the Stress, Apparently

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By Kevin Fayle on May 07, 2009 12:31 PM

Ok, ok, I know what you're thinking: "Not another post about the government's 'stress test' for banks!"

But this one's different, I promise.  The results are finally in, and they aren't as dire as once feared.  In fact, some banks even want to start paying back some of the funds they received from the Troubled Asset Relief Program (TARP).
The stress tests have revealed that other banks - 10 out of the 19 tested, in fact - must raise capital in order to keep going, but the government isn't indicating that any of the banks will go under either now or if the economy worsens.

It's already known that Bank of America will have to raise $34 billion in additional capital.  BofA has started looking for ways to do that, including selling its stake in China Construction Bank or converting the preferred stock that the government now holds into common stock.  That would make the taxpayers the majority shareholder in the bank.

Despite this $34b shortfall, BofA's shares still went up along with the rest of the financial industry as investors signalled their overall optimism in anticipation of the results' release.

Some banks are pretty optimistic themselves, and have asked the government to allow them to retun a portion of the bailout money they received from the government months ago.  The banks have two main reasons for wanting to do so.  First, it shows investors that they are financially strong and confident; and second, it would get them out from under the government's harsh rules concerning executive compensation that were instituted as a condition of receiving the funds.

The Treasury Department isn't committing to anything yet, however.  Treasury wants to make sure that the banks are actually healthy enough without the TARP money to keep lending.  The government has set a condition (the government, as we all know, is very good at setting conditions) that banks will have to show that they can get by without an FDIC debt guarantee that allowed firms to borrow money on the cheap.

In order to get the green light to repay TARP, banks will need to show the government that they can issue debt to private investors without the guarantee.  Several banks have already begun doing so.

After the banks have demonstrated their ability to issue guarantee-free debt to the government's satisfaction, the banks can return the TARP money and start handing out lavish executive compensation packages again.

Which will encourage risky behavior and probably wind up fomenting another financial crisis.

Lather, rinse, repeat.

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