• 
• 
• 

The day of reckoning is close. Finally, the Obama administration is getting ready to conduct "stress tests" on the United States' biggest banks. By doing so, the administration will be in a position to judge whether the largest banks - which have just received a liquidity injection from the US Treasury Department to the tune of US$700 billion (Bt25 trillion) - will be able to hold up if the recession were to worsen over the next two years. These big banks include Citigroup, Bank of America, JP Morgan Chase, Wells Fargo, Morgan Stanley, Goldman Sachs, PNC Financial Service Group, and other institutions. The stress tests are expected to go ahead at any moment. The banking regulators will determine whether the banks have enough capital to cushion them from severe shocks over the next two years.

So far the Obama administration has been reluctant to take a bold step in resolving the banking crisis once and for all. It is afraid of violating the taboo of bringing the banks under government control. Nationalising the banks is an ugly concept in Washington DC. But there is no way out of this crisis in the US banking system except to deal with the insolvency issue in a straightforward way. If banks do not have enough capital adequacy, they will not be in any position to do business. The counter-parties will have no confidence in their health, nor will investors and customers.

Initially the Bush administration, which introduced the $700 billion bail-out package, simply wanted to remove the bad assets from the balance sheets of the banks. The capital increase would come later on. Eventually the US government ended up holding sizeable stakes in the big banks and Wall Street firms which have transformed into banking institutions. But the rescue plan was conducted piecemeal. A comprehensive solution was absent.

The Obama administration has inherited the problem of the banks' insolvency. The only way to deal with this insolvency is to increase the capital. But to increase the capital in the banks without punishing the shareholders first by writing down the capital is like throwing good money after bad - because nobody knows where the bottom of the crisis is.

The US is facing a classic balance sheet recession as Wall Street has hit a 12-year low. Global financial markets have also fallen sharply because investors are nervous about the absence of a clear resolution to deal with the US banking crisis. US households and businesses need to reduce their debt load. The banks are not lending because they want to protect their capital for fear that further lending into the weak economy will create even more bad debts.

By the way, most of them have been kept afloat by capital from the taxpayer.

So the Obama administration has to come up with more than $787 billion in its economic stimulus package in order to prop up the economy, to prevent further job losses, to provide investment in public projects and to keep domestic consumption alive.

Testifying before a Senate panel on Tuesday, Federal Reserve Chairman Ben Bernanke sought to calm fears that the government was heading down the path of nationalising troubled banks.

"We've always worked with banks to make sure that they're healthy and stable, and we're going to work with them now. I don't see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalise banks when it just isn't necessary," Bernanke told the senators.

"The outcome of the stress test is not going to be fail or pass. The outcome of the test is how much capital does this bank need in order to meet the credit needs of borrowers in our economy?"

Still, if some US banks fail the stress tests, they can expect to see the US Treasury converting preferred equity into common shares, hence diluting the equity of the existing shareholders. By doing so, the US Treasury would effectively nationalise some of the banks.

The problem does not end there because the $700 billion earmarked during the Bush administration is not going to be enough. Speaking to Congress on Tuesday, President Barack Obama said more money would be needed to rescue troubled banks beyond the $700 billion already committed last year. Saying he understands bank bail-outs are unpopular, he insisted it was the only way to get credit moving again to both households and businesses. He also called on Congress to move quickly on legislation to overhaul regulations for the nation's financial markets.

The full drama is about to unfold. Many banks will still go under, and investors have yet to see the crisis bottom-out.