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WASHINGTON (AP) The big banks got through the government's "stress tests" with only minor bruising. But a bigger test awaits them: Getting rid of the bad assets that helped ignite the financial crisis in the first place.

Stress tests do little to fix banks' asset problem
With stress tests behind them, banks turn to the toxic assets that still plague balance sheets

http://finance.yahoo.com/news/Stress-tests-do-little-to-fix-apf-15190399.html?.v=5

* Daniel Wagner and Stevenson Jacobs, AP Business Writers
* On Friday May 8, 2009, 6:23 pm EDT

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* JPMorgan Chase & Co.
* , Wells Fargo & Company

WASHINGTON (AP) -- The big banks got through the government's "stress tests" with only minor bruising. But a bigger test awaits them: Getting rid of the bad assets that helped ignite the financial crisis in the first place.

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http://finance.yahoo.com/news/Stress-tests-do-little-to-fix-apf-15190399.html?.v=5

It won't be easy. A Treasury program announced three months ago to help private investors buy up those assets hasn't even begun. Some banks are threatening not to participate. They fear they won't fetch a high enough price for their soured mortgage-related debt, which was bought at the height of the housing boom.

Removing the bad assets is needed to fix the banks and help revive the economy. Unless they can sell off these assets, banks won't be able to resume normal lending and rebuild confidence in the financial system, even if they have enough money to survive.

The International Monetary Fund has estimated U.S. financial institutions could ultimately lose $2.7 trillion from the global credit crisis.

The stress tests said the 19 largest banks could lose $600 billion by the end of 2010 if the recession worsened. Of that sum, about $135 billion involves trades with other banks and investments, including mortgage-backed securities -- the kinds of assets that have come to be called toxic.

But many experts say those estimates undercount potential losses on bad assets.

One reason is the tests didn't assess such risks for firms with less than $100 billion in their trading portfolios. Another is that the calculation of capital levels assumed the assets were worth what banks say they are, not what the market would pay.

The tests helped clarify the banks' capital needs, said Richard R. Zabel, an accountant at Robins, Kaplan, Miller & Ciresi. But they didn't make dealing with the core of the financial crisis -- troubled bank assets -- any easier, he said.

By itself, pumping $75 billion more capital into 10 of the nation's 19 largest banks, as prescribed by the stress tests, "won't eliminate the problem" of bad assets, he said.

"The stress tests were hypothetical," Zabel said. "Now we have to deal with reality, and until you remove toxic assets, they are going to be an issue. If we continue to have home foreclosures and high unemployment, the value of these assets are going to continue to deteriorate."

The banks' bad assets -- those that have lost value or can't be sold -- were the target of Treasury Secretary Henry Paulson's original bank rescue plan last fall. His successor, Timothy Geithner, outlined his own plan to help private investors buy up the assets on Feb. 10.

The program aims to entice investors to buy up to a half-trillion dollars of bad assets, to shore up banks' capital and unlock credit. The program could later be expanded to $1 trillion.

So far, there's been little sign of progress.

Treasury started accepting applications from private companies that want to manage the program, then changed the terms. It announced last week that it had received 100 applications to participate. But Treasury has yet to provide much detail about how the program will work. Large banks, including JPMorgan Chase & Co., have balked at signing up, wary of possible federal curbs on executive pay.

In an interview this week on PBS' "The Charlie Rose Show," Geithner said the program will be "up and running in the next four to six weeks."

He described the program as a companion to the stress tests, saying, "The stress test will increase certain incentives to sell, because it will require them to hold more capital against the loans on their balance sheets."

But the stress tests undercounted the banks' possible losses on complex assets, said Frederick Cannon, of the research firm Keefe, Bruyette & Woods.

Cannon said he was shocked that the test didn't forecast Wells Fargo & Co. losing any money from its exposure related to other institutions' debt. He said the bank acknowledged in a recent filing it had $120 billion at risk if guarantees on certain investments go bad.

The government applied a harsh test to loans the banks hold, Cannon said, but used a more lenient test for assets. Firms with less than $100 billion in their trading accounts were not even evaluated for this kind of risk.

And they were required to hold capital against only half their mortgage-related securities -- a formula for "risk-weighted assets" that Cannon said is outdated.

In recent years, banks started relying on increasingly complex securities deals to spread risk across the system. Many of their problem assets are hard to value, because they're backed by huge and diverse pools of mortgages.

Once home values began falling in 2007, owners started having trouble refinancing mortgage loans. Defaults rose. That caused bank assets to lose value. Soon, buyers became unwilling to pay market rates for a wide swath of mortgage-related assets, even those that were performing well.

Uncertainty about what these assets are worth is preventing the financial system from fully recovering, experts say. Buyers are unwilling to pay anything close to what the banks say they're worth.

"There's no fire sale, and the guys who want to buy stuff would rather buy from people who are under pressure," said Simon Johnson, a former IMF chief economist now at the Massachusetts Institute of Technology's Sloan School of Business.

He pointed to problems with the government's strategy, including its willingness to keep pouring billions into the banks. Banks "feel no pressure to sell" because they are confident the government will keep subsidizing them, Johnson said.

Taxpayer advocates also say Treasury's plan puts too much risk on taxpayers and too little on the private investors. In report last month to Congress, the special inspector general for the financial rescue said the program favors private investors and creates "potential unfairness to the taxpayer."

The program "is so large and the leverage being provided to the private equity participants so beneficial, that the taxpayer risk is many times that of the private parties, thereby potentially skewing the economic incentives," the report said.

But the program doesn't have to deal with every bad asset the banks hold. All the government has to do is "chum the waters" with enough subsidies that private investors start buying again, said William Seidman, who headed the Federal Deposit Insurance Corp. during the savings and loan crisis.

That's one reason the government is providing such low-risk financing to the hedge funds and others that take part in the program, said Christian Menegatti, lead analyst at RGE Monitor.

Hedge fund manager Steven Persky, who's raised $400 million to buy mortgage-backed securities, said his firm has applied to participate in the private-public partnership. But he hasn't decided if it will.

A big problem, Persky said, is that the rules still haven't been clearly laid out three months after the program was announced.

Investors, for example, still don't know if they'll be subject to federal compensation limits applied to bank executives whose firms took money from Treasury.

"I'm interested," Persky said. "But it's still not clear to me what the rules are."

http://finance.yahoo.com/news/Stress-tests-do-little-to-fix-apf-15190399.html?.v=5

Stevenson Jacobs reported from New York.