Update: After extended-hours trading was closed, the WSJ reported ‘Banks Won Concessions on Stress Tests’. Looks like the sources I quoted in this post were dead-on.

We finally got the worthless and leaked stress-test results. People are abuzz about capital ratios and Treasury’s ridiculous new acronyms. But of all the capital measures, which is the most important for a bank’s success? Their political capital, of course. I am slightly mangling the accepted use of political capital here, but that’s necessary for this play on words to work. Think “influence with politicians and Fed officials”.

Banks with sway over Treasury were intimately involved in designing the stress test. They were able to influence the general strategy of the tests, ensuring they weren’t very stressful at all. They also made sure the tests would not focus on areas that may expose their weaknesses (derivatives, for example).

Unfortunately many small banks will not survive, and don’t have unlimited government guarantees. Who will be there, willing to scoop them up for next to nothing? The best of breeds, of course. Of course they’re the strongest, how can small banks compete with unlimited government-backing? They can’t.

And now, let’s hear from some more credible voices than mine. This statement from William Black, former head of the Office of Thrift Supervision, speaks volumes:

Bottom line: there were no real examinations. Banks continue to overstate asset quality. The bankers pressured Congress, which extorted the Financial Accounting Standards Board, which gutted the accounting rules on loss recognition.

…We know that Treasury used a “one size fits all” stress test that grossly understated derivatives risk — the primary risk that the largest banks face.

Politically influential banks played a major role in shaping the stress tests. And they got to negotiate their results. What? Yves Smith of Naked Capitalism says:

First, they were administered by the industry based on scenarios provided by the industry… Even worse, banks got to use their own risk models, the same ones that got them into trouble.

Second, the industry got to negotiate the results. This is simply unheard of. That suggests both a lack of confidence in the process and a lack of belief on the part of the key actors

The above quotes are from this great collection of comments about the stress test. Their charges should be answered by Geithner and the boys, but they won’t be. So we need to make sure two things happen:

  1. Geithner gets fired, ASAP. Please replace him with William Black, a realist and a smart man. Simon Johnson would be another good choice.
  2. The Fed gets audited. Passing Ron Paul’s Federal Reserve Transparency Act is imperative.

If your Congressmen hasn’t signed on as a co-sponsor of Ron Paul’s bill (HR 1207) please write them now. With these bank cronies in power, we’re never going to make any real progress.