When the stress tests were first announced, I suspected that they were a convenient backdoor to nationalizing the country's banks. The Obama administration couldn't allow the banks to keep operating without government-supplied life jackets, safety nets, crash helmets, etc. And a piece-by-piece bailout of the banking sector was only harming the administration's standing with the public and economists. The media's echo chamber craves an all-or-nothing stance; start-and-stop bailouts occupy the unsatisfying middle ground. But lacking dramatic new data, the administration didn't have the political cover it needed to seize the banks themselves. So, what to do? Create new data.
That, as we now see, is exactly what the stress tests have done. And it's not just data that's been manufactured; it's opportunity. The tests have given the government an excuse to finally begin nationalizing the banks that most need to be nationalized. Whether it was all part of the plan or not, it amounts to a long con. The federal government has forced Bank of America—and maybe other banks—into forking over an ownership stake. And there's nothing Republicans can do about it.
After weeks of rumors and news leaks, we now have confirmation that Bank of America needs about $34 billion more than it has. This is the same Bank of America to which the government has already given $45 billion of TARP money. B of A has one month to figure out how to raise that capital. In this market, one does not come across $34 billion easily. Bank of America will need help from the federal government.
And we won't be injecting new money into B of A. The feds will be taking the money they already gave the bank and morphing it into a different kind of money. (Yes, when it's put that way, it sounds like magic. It may as well be.) What will likely happen: a conversion of the government's preferred shares into common stock. (To read about the preferred-common transformation, this piece on how it worked at Citi is a good, but dense, start.) As of now, the government doesn't quite own shares of B of A as you and I would if we bought its stock. It has given B of A $45 billion via loans and other fancy financial packages that are a sort-of placeholder for an ownership stake, if it ever wanted it. Essentially, it called fives on B of A stock. And now the time has come to cash in the placeholder coupons. It's forcing B of A to allow it to take partial control.
But, you say, isn't that effectively nationalizing the bank? Isn't that what the Obama administration said it didn't want to/couldn't do? Yes, but now it's not just doable; it's an imperative. Why? Because, thanks to the stress tests, we have new data. New data that justifies the path to nationalization.
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And that data is inherently flawed and inherently arbitrary. Just as a teacher decides how to grade a test, the government was the one that decided how to test the banks. The Treasury still hasn't announced the rubric, but we know it involved something called "tangible common equity," the definition of which doesn't matter for our purposes. Each bank needed a certain amount of TCE to pass the test. That amount—rumored to be 4 percent—was higher than expected. The higher the amount, the tougher the test. The tougher the test, the more money the banks are going to need to raise.