Rise of the Zombies

From Pariah to Most Desired: Banks Raising Billions But Faith May Be Misplaced
Posted May 11, 2009 10:38am EDT by Aaron Task in Investing, Recession, Banking

Related: JPM, WFC, BBT, COF, KEY, USB, XLF

Capital One, BB&T, KeyCorp. and US Bancorp on Monday joined the veritable conga line of banks raising capital and planning to repay TARP with the proceeds. The stock and debt offerings come in the wake of Friday's stress tests results and seem to secure the financial sector's two-month transformation from pariah to most desirable.

The fact banks, including JPMorgan, Wells Fargo and Goldman Sachs in addition to the aforementioned, are able to raise money from private sources is an unalloyed positive. Treasury Secretary Tim Geithner deserves major kudos for navigating the stress-test course with great success and aplomb, at least to date. Investors are understandably flocking to the financials because the market (not to mention the government) is sending a very strong message about their solvency and stability.

However, we can't help think investments made in many of these investments banks will come back to haunt the buyers - maybe not tomorrow, maybe not next week, but eventually - for the following key reasons:

How stressful were the stress tests? As discussed here (and elsewhere), the stress tests were not particularly stressful in terms of assumptions about the economy or compared with the past "nuclear winter" tests that Fannie and Freddie were said to have passed (before being declared insolvent.)

Everything is negotiable: The WSJ details how the banks pushed back against the government's initial capital requirements. Some back and forth is fine and just but how the government changed its original determination that Citigroup needed to raise $35 billion to a mere $5.5 billion is a head-scratcher that requires additional investigation (or the total suspension of disbelief.) Similarly, The FT reports the government is letting bank count future earnings against current capital needs, which would seem to be an invitation for some mark-to-market accounting magic in the coming quarters.

Rise of the Zombies: Amid all the hubbub about the stress tests, the bottom line is the banks are still saddled with tons of toxic debt, and nothing that's occurred so far changes that reality. So how is what we're doing materially different from what Japan did with its problem banks back in the 1990s? Meanwhile, the number and type of bad loans continue to rise and U.S. banks are, understandably, wary about lending money in the current economic environment.