The "Open Book" Stress Tests

Well, the results of the "Stress Tests" on major American financial institutions are in, and unbridled optimism runs wild in corporate media. Only $75 billion required to guarantee solvency! No more desperate pleas to the Federal Reserve or the Treasury for more money coupled with those annoying "restrictions" on salary or bonus pay! The unemployment rate "stabilizes" at 8.9%! Beyond the hoopla many economists and financial professionals still have some very pointed questions concerning the validity of the tests and the ongoing health of the economy in general. Economist's View's Mark Thoma wonders about the validity of the stress test "mean":
Depending on the "questions" they ask the balance sheets, and how the answers are scored, they can get whatever mean they desire (e.g. how are assets that cannot be valued in the marketplace are "scored' makes a crucial difference in the outcome) ... A big part of the problem with bank balance sheets is the things we cannot see, do not know about, and cannot predict. How were those things accounted for in the stress tests?
Think Progress's Fazid Shakir, citing an item in The Wall Street Journal, reveals the "accounting" procedure; they fudged it:
The Federal reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks, shortly before concluding its' stress tests, following two weeks of intensive bargaining. .... (T)he Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital defecits.
Not content to merely fudge capital defecits, the Fed in its' infinite wisdom also increased taxpayer risk. Wonk Room's Pat Garafolo describes a new "financial instrument" custom-made to transfer preferred stock to common-stock equity:
While the banks will presumably do their best to go out and raise capital from private investors ... they will have the option of converting the shares that the government bought with the initail round of TARP into a new financial instrument ... a "mandatory convertible preferred" share gives the banks the ability to create common equity as needed. The preferred shares convert to common shares when a bank or its regulator decides they should. ... (A)s Robert Reich points out "by this sleight-of-hand the public takes on more risk", moviing from a preferred creditor to a common shareholder.
Given the "Geithner paradigm" (throw trillions of taxpayer dollars at financial institutions judged "too big to fail" while alleviating risk to said institutions whenever possible) both the stress tests and the conversion of preferred stock to common equity constitue more of a public relations makeover than any tangible measure of financial solvency. For a big-picture look at the varieties of insolvency that continue to plague us we turn to an amazing overview pithily entitled Why We Are Absolutely Screwed by Karl Denninger:

1) There are 19 million empty homes in America and the builders are still building.

2)Prices were cranked far too high and still have not come down to historical norms in terms of price-to-income ratios. Until they do, a normal market cannot be restored.

3) Everyone in government has been attempting to prevent (the decline to normal p-t-i ratios) for the last 3 years, and have blown hundreds of billions attempting it. They have and will fail.

4) The boomers will not be needing all those extra homes. They're starting to retire. ... (A) 1 or 2-bedroom condo is just fine when all the kids are gone and you've retired.

5) There are only about 44 million " Gen-Xers" and they're stuffed to the gills with college loans. ... They can't afford the 4 and 5-bedroom houses.

... Steve Liesman gave us the "money" quote this morning (May 7th) on CNBC. None of these banks would survive on 11 or 12% unemployment. ... (T)he actual unemployment rate in the country - it includes those who are "discouraged" (they've given up) along with those who are working part-time because they can't find full-time work.
It is well over 12% right now!