From the desk of Ed Yardeni

I was starting to compose something similar to the following piece from Ed Yardeni. After reading his piece I decided it was best to yield to the master and share Ed's thoughts. His are very similar to mine. I strongly encourage rearders to go to yardeni.com.

Credit derives from Latin, credere, “to believe.” Apparently, investors don’t believe that the government has done what it takes to fix the credit system. Indeed, there is widespread speculation that many banks will have to be nationalized. They already are on a de facto basis. Yesterday, Joe and I observed that since February 2008, the S&P 500 Bank Composite’s market cap has tumbled from $508bn to $111bn on Friday last week. Think about that: The government can buy the entire banking system for chump change. It can buy the entire S&P 500 Financials sector for $598bn at yesterday’s close. Stock investors seem to be resigned to bank nationalization. In effect, they are telling Washington, “Go ahead, you damaged them, you can have them.” Why should the government waste any more money on programs to provide capital injections to the banks? Take them all. That way all bank deposits and bank debt will be government guaranteed. Barney Franks can make sure they lend money to his friends and relatives. Chris Dodd can refinance his mortgage. Wouldn’t it be a great big joke on us all if the government suspends mark-to-market accounting for the banks it nationalizes? All this time, the Capital Kleptocrats refused to do so to protect investors in bank stocks. Now that they’ve wiped out those investors, who cares whether the nationalized banks’ books add up!

Of course, nationalization doesn’t guarantee that the bleeding will stop. AIG was taken under protective custody by the Feds on September 16. The firm's Q4 results, which may be announced next week, will probably include $60bn in writedowns on assets including securities tied to commercial mortgages. AIG’s rescue package was expanded to about $150bn in November from $85bn in September as regulators tried to reduce losses at firms that did business with the company. This strongly suggests that the additional $200bn allocated on February 18 to Fannie and Freddie by the administration won’t be available for making additional mortgage loans, as was implied, but never explicitly stated. Fan & Fred were placed under house arrest on September 7, and provided with $200bn in living expenses, i.e., fresh capital, by the Feds.

Meanwhile the charade goes on. The Treasury, the Fed, and the other banking regulators issued a statement yesterday (linked below) suggesting that they really don’t want to nationalize the banks unless they have to…yeah, right! Here are the sordid details:

(1) “The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses.” The Feds stood right behind the banks, TRAPed them, and pushed them right off the cliff.

(2) “We announced on February 10, 2009, a Capital Assistance Program to ensure that our banking institutions are appropriately capitalized, with high-quality capital. Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment.” The Feds are certainly doing their best to make it more challenging, which means they will have no choice but to take all the banks into protective custody the way things are going.

(3) “Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government. This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis. Instead, it is available to provide a cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers.” The Feds don’t explain how it can be that large losses require only temporary cushions, and how long is temporary.

(4) “Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion feature will enable institutions to maintain or enhance the quality of their capital.” How exactly is this different from stealth nationalization?

(5) “Currently, the major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized. This program is designed to ensure that these major banking institutions have sufficient capital to perform their critical role in our financial system on an ongoing basis and can support economic recovery, even under an economic environment that is more challenging than is currently anticipated.” Say what? Are the banks well capitalized, or are they insolvent? You and I don’t get to decide.

Who writes these official statements? Even Greenspan was easier to understand. Who was the sadist who came up with the idea to “stress test” the banks? Treasury Secretary Geithner announced the stress test plans on February 10, but initially provided little information. Yesterday’s statement suggests that the Feds will begin running banks through rigorous tests to measure whether they hold enough of a cushion to continue lending during the downturn. This morning’s WSJ warily observes, “The federal statement still stopped short of explaining what economic conditions the government would simulate to determine a bank's health. Officials said Monday they will likely consider a series of nightmarish economic scenarios, including drastically lower housing prices, rising unemployment and continued negative growth. They will ask some 20 banks to predict losses for these events against asset classes such as auto loans, mortgages and commercial credits.” I can easily predict the results of these stress tests: Cardiac Arrest! Then quadruple-bypass through nationalization.

In yesterday’s WSJ, William Isaac wrote that nationalizing the banks now would be a really awful idea. He should know: He headed up the FDIC when Continental Illinois Bank was nationalized in 1984. He argues that today’s large banks are too big and complex to be run by the government. Shrinking the banks now would only worsen the credit crisis. Replacing so many bank managers would be an impossible task. Sweden’s successful bank nationalization experience of the 1990s is almost entirely irrelevant to the United States.

The stock market isn’t coping well with the administration’s stress test. Investors see through the fog created by the Feds, and don’t like what they see.