Wall Street finally out of the woods

Allister Heath
WALL STREET’S financial crisis is almost over – or so the Federal Reserve would like us to believe. It rushed out the results of its stress tests of the 19 biggest US banks last night: just four failed – in all cases relatively narrowly – a test which gauged their ability to withstand a financial shock that includes unemployment hitting 13 per cent, a 21 per cent drop in house prices, a 50 per cent slump in equity markets and chaos caused by a bank collapse elsewhere (read Europe). They needed to be able to show that they would retain Tier I common capital above 5 per cent; only then would they be allowed by the Fed to start returning money to shareholders.

Some major institutions did well enough to be allowed to launch massive dividend payouts and share buybacks, including JP Morgan and American Express. So should we rejoice? Is the Fed right that the crisis is almost over, at least as defined by the financial health and robustness of Wall Street’s largest institutions? Investors certainly think so. The Nasdaq finished over the 3,000 mark for the first time since December 2000; the Dow reached 13,177, its best level since before Lehman Brothers went bust. The S&P 500 has had its best start to the year since 1991.

Last night’s developments are good for London, where US banks such as Goldman Sachs, Bank of America Merrill Lynch, State Street, Bank of New York and Morgan Stanley employ tens of thousands of workers and indirectly support many tens of thousands others in fund management, law, consulting, IT and recruitment, as well as property, retail and all other walks of life. That said, Citigroup failed the test, as did insurers MetLife, another big London employer.

Some critics believe US banks should not have been allowed to pay dividends until they met all of the Basel III rules, even though these are not actually binding yet. I disagree: these tests were tough enough.

As Capital Economics points out, banks were examined not just for potential losses on loans and securities holdings, but also “on trading and counterparty positions under a severe shock to global financial market rates and prices.” Such a scenario would mean $534bn of losses over the next nine quarters (including $341bn in loan losses and $116bn in trading losses), more than offsetting $294bn in revenues. It is unlikely that US house prices, which have collapsed and are now cheap in many states, will plunge a further 21 per cent on any realistic scenario, so the test seems to make sense, unlike some of the nonsense recently released by the European authorities. The US economy is recovering, with much better job creation.

But while US banks are doing better, the rest of the world isn’t out of trouble. Many institutions remain in crisis in the Eurozone, though their immediate problems have been camouflaged by the European Central Bank’s Long-Term Refinancing Operations. These have injected huge amounts of liquidity into the system, which is what central banks are meant to do in contemporary monetary systems. But the LTRO has also served to secretly bail out insolvent institutions, which is not right; numerous banks across the Eurozone remain in dire straits, even before any further sovereign crisis. Wall Street is on the mend – but huge problems remain in the Eurozone and Chinese financial systems. Until these are tackled, the global economy will remain under a cloud.

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