New concerns arise about bank health

Tuesday, April 21, 2009

WASHINGTON -- Anxiety is growing again over the health of the nation's largest banks, and with Congress hesitant to commit more money, the Obama administration is exploring ways to strengthen them in the face of the recession.

Results of the federal government's "stress tests" on big banks are due May 4, and many on Wall Street are increasingly worried they will show some banks are in worse shape than expected.

The renewed bank fears drove the stock market down Monday in its worst showing in six weeks. Bank of America stock lost nearly a quarter of its value, and the Dow Jones industrial average fell almost 290 points.

Bank of America reported a first-quarter profit of $2.8 billion, joining other banks whose earnings reports have looked positive at first blush. But some analysts say accounting steps are concealing the depth of the financial industry's woes.

Banks have been helped by income from trading and cheap borrowing, but they are still struggling with bad debt, said Joe Saluzzi, co-head of equity trading at Themis Trading LLC.

Investors are "looking at bank numbers and are saying they are not that great," he said.

Among the ideas being explored by the administration is converting the government's loans into equity stakes, which would improve the banks' bottom lines by increasing their capital reserves.

The Treasury Department will outline Friday how it plans to structure the stress tests, which aim to gauge the health of 19 big banks. So far, investors have been too optimistic about the results, warned Jaret Seiberg, a financial services policy analyst at Washington Research Group.

"What we're seeing is a re-evaluation of those positions," he said. "Until we have finality on what the stress tests will tell us, the markets will be very jittery about the banks."

The $700 billion in bailout money approved by Congress last fall has dwindled to about $135 billion, and the administration is under pressure to show it has other tools to strengthen weaker banks.

Critics have said the bailout money has failed to get banks to resume more normal lending to consumers and businesses. Increased lending is seen as vital to ending the financial crisis.

Congress has signaled that additional money is unlikely, in part because of public outrage over executive bonuses at banks getting taxpayer money.

"They understand that we need an exit strategy from the continuing cycle of bailouts," said Rep. Spencer Baucus of Alabama, top Republican on the House Financial Services Committee.

Asked Monday whether Congress would provide more money, House Financial Services Committee chairman Barney Frank, D-Mass., said: "Not at this point, no."

The government has lent nearly $240 billion to more than 540 banks since fall, much of it in return for preferred stock. Holders of preferred stock are paid back before holders of common stock if a company goes bankrupt.

Converting government loans from preferred stock into common shares might help reassure investors and customers, though it would hurt existing shareholders by reducing the value of their shares.

But some private economists support the idea, noting that the Treasury Department put such a plan in place for Citigroup in February as a way of restoring confidence in the bank.

"I think Citigroup was a very good test case," said Sung Won Sohn, an economics professor at California State University and a former president of a Los Angeles bank. "It was a large troubled bank that needed more capital. Without the government's help, Citigroup could have gotten into deeper trouble."

Converting preferred stock into common stock could show lawmakers how far regulators will go to buy time for financial firms that need more capital, said Simon Johnson, a professor at the Massachusetts Institute of Technology's Sloan School of Management.

"In some ways, it's an appeal for money," he said. "The stress test is going to say they need capital. ... So at some level, they're communicating with Congress."

Concerns about the banks weighed heavily on financial stocks Monday, and not just Bank of America. Citigroup stock lost 19 percent of its value, Wells Fargo & Co. 16 percent and JPMorgan Chase 11 percent.

The deepening recession only makes business worse for the banks, and the nation is still waiting for sure signs that the economy is improving, or at least stabilizing.

On Monday, the Conference Board said its monthly forecast of economic activity fell 0.3 percent in March and has not risen in nine months. The decline was more than expected, but the board did call for the recession's intensity to ease this summer.

The government has said that any banks found to need extra capital under the stress tests will be given six months to raise that capital on their own. If they can't, the government will provide it.

Some on Wall Street are skeptical that the tests will be tough enough.

"Of course, everyone will pass because we don't want to create a panic," said Axel Merk, president of Merk Investments. "We're going to have the illusion of healthy banks but they won't want to lend."


AP Economics Writer Christopher S. Rugaber, AP Business Writer Daniel Wagner and AP writers Deb Riechmann and Anne Flaherty contributed to this report.

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