Kudlow’s Money Politics

Stress-Test Uncertainty

Big news today for the banks: The White House and Treasury announced that the economic stress-test results for the 19 largest banks will in fact be made public on May 4.

This whole stress-test business has opened up a Pandora’s box of difficult issues. No banks are going to fail, per se, but some will do better than others. We’ve already seen strong earnings reports from Wells Fargo, Goldman Sachs, and today JPMorgan Chase. Everyone is now waiting for Citigroup and Bank of America, two that are often regarded as weak sisters.

Will the stress-test results slam banks and the overall stock market, pushing each way down? Could the results wind up killing confidence, erasing the confidence-progress of the past two months?

There’s no question that once the government decided to run these stress tests to model worst-case economic scenarios, that the banks would be forced to report the results. New regulations by the SEC insist on transparency. It’s called the 8-K SEC filing. Individual banks may get their own results out before the Treasury does. That’s another issue, and presumably the stronger ones will do this. But the whole story is a cautionary tale for investors right now.

JPMorgan CEO Jamie Dimon said today that he wants to get out from under TARP, which he regards as “a scarlet letter.” Goldman Sachs is also ready to pull the de-TARP trigger. So is Wells Fargo. But here’s a key question: Will the de-TARPed banks move completely out from under government control?

Paying down TARP may not be the last word. Many of the big banks have issued large bond offerings under FDIC guarantees. Of course, the offerings sold easily since government backing makes the bonds risk-free at cheaper rates. But will the onerous TARP restrictions on compensation, H-1B foreign-visa hiring, and dividend- and share-buyback policies all be suspended with a TARP pay-down, or will the government’s bond guarantees keep these banks under those restrictions? No one knows.

So one really big question is whether Team Obama will relinquish control over most of these banks, or whether the bureaucracy will do everything it can to maintain control.

I still believe the best bailout policy for the banks is the upward-sloping Treasury yield curve created by the Fed’s easy-money policies. Borrowing short at near-zero interest and lending long at 5 or 6 percent is the ultimate solution to the credit crunch. Most of these banks will have the capacity to earn their way out of the toxic-asset problem. And the scoring of those toxic assets has been made somewhat easier as a result of mark-to-market accounting reform from FASB and the SEC. However, Jamie Dimon said today that his bank will not play in the Public-Private Investment Program (PPIP) created by the Treasury. That probably means his strategy is to earn his way out of the toxic-asset value problem. It also means he wants to stay away from any government programs that will interfere with the running of his bank.

So the stress-test issue is going to unlock a lot of these questions. But it also adds considerable uncertainty to the answers.

Larry Kudlow — Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

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