Can Fifth Third be made whole?

Posted by Marc Hodak on May 9, 2009 under Politics | Be the First to Comment

Did Fifth Third need $2.6 billion in additional reserves, instead of the $1.1 billion claimed by the final results of the “stress test”?  Or was this the kind of test where you could negotiate your grade?

The basic problem with estimating required capital reserves is that we’re measuring an inherently uncertain variable, i.e., the likelihood of a bank running out of cash under very bad economic conditions.  To properly evaluate this, the analyst must quantify the bank’s assets and liabilities, the degree to which they would vary under a broad range of possible future environments, including how the different parts of that environment would vary with respect to each other, as well as how significant changes in those various parts would impact the various assets and liabilities of the subject bank.

I would guess that even if the Fed came close to having the tools to do this right, political management would render it impossible to properly bring those tools to bear on the problem in the few months these tests have been conducted.

Given the difficulty of the question, the inherent uncertainty around any answer, and the practical stakes held by distinct interests in those answers, we have a recipe for a very silly exercise, which is what we got.  While it’s clear that the banks wanted to have as low a number as possible for the capital deficit, it’s not clear that the government had any interest in seeing any particular number for any particular bank, except that the overall report should look like it came up with plausible answers.  In other words, all the banks couldn’t have a zero deficit, or the same deficit, or anything else that looked like what a third or fifth grader would have come up with on an afternoon with a spreadsheet.  Politics dictated that the numbers couldn’t be too big, either, enough to spook the markets into thinking that widespread insolvency was a possibility.

So, we ended up with a negotiation.  This article gave a hint about how that went:

“In the end we agreed with the number. We didn’t necessarily like the number,” said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed’s assumptions about Wells Fargo’s revenue outlook.

At Fifth Third Bancorp, the Fed was preparing to tell the Cincinnati-based bank to find $2.6 billion in capital, but the final tally dropped to $1.1 billion. Fifth Third said the decline stemmed in part from regulators giving it credit for selling a part of a business line.

Citigroup’s capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. Executives persuaded the Fed to include the future capital-boosting impacts of pending transactions.

SunTrust Banks Inc. also persuaded the Fed to significantly reduce the size of its estimated capital gap to $2.2 billion, after identifying mathematical errors (!) in the Fed’s earlier calculations, according to a person familiar with the matter.

PNC Financial Services Group Inc., saw a capital hole materialize at the last minute. As recently as Wednesday, PNC executives were under the impression they wouldn’t need to find any new capital, according to people familiar with the matter. Thursday morning, the Fed informed PNC that it had a $600 million shortfall.

So, does PNC really need $600 million to make it through a really bad time (worse than what we’ve just gone through)?  Does Fifth Third need $1.1 billion or $2.6 billion?  Will the $1.5 billion difference make then more or less competitive?  How did competitiveness figure into the estimation of their survivability?  Somehow, I doubt that the central planners come up with a better answer than doing nothing.  But doing nothing is clearly not an option for the central planners.