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Speaker 1: Global business news twenty four hours a day at Bloomberg

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Speaker 1: This is a Bloomberg Business flag from Bloomberg World Headquarters.

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Speaker 1: I'm Charlie Pellett. Strongest gain in a month for the

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Speaker 1: SMP five hundred index, advancing one point three percent. UK

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Speaker 1: citizens voting today in a referendum on the country's membership

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Speaker 1: in the European Union. UK law prevents us from reporting

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Speaker 1: on voting or discussing and analysis of referendum issues while

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Speaker 1: polls are open, but we are following all the action

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Speaker 1: and we will pass along results with special coverage as

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Speaker 1: those details become available. S and P five hundred indexs

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Speaker 1: up twenty seven points to thirteen, a gain of one

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Speaker 1: point three percent. Nev Stack up seventy six points, a

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Speaker 1: gain of one point six percent down, ind Us Reels

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Speaker 1: up two hundred thirty points, a gain of one point

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Speaker 1: three percent, the yield on the ten year one point

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Speaker 1: seven four percent, down sixteen thirty seconds, Gold down ten

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Speaker 1: ninety a ounce to twelve fifty nine, a drop of

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Speaker 1: point time percent. And Crude West Texas Intermediate picking up

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Speaker 1: two percent today of a dollar one fifty dollars now

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Speaker 1: fourteen cents fifty fifteen on West Texas Intermedia Crude. I'm

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Speaker 1: Charlie Pellett and that's Subloomberg Business Flash. You're listening to

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Speaker 1: taking Stock with Pim Box and Kathleen Hayes on Bloomberg Radio.

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Speaker 1: It's past failed. But the feder Reserves stress test either

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Speaker 1: you have enough capital with standished severe economic shock or

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Speaker 1: you don't. That's why we're gonna dive now into the

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Speaker 1: results on the latest dress test just announced by the

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Speaker 1: Federal Reserve with a man who is known for his

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Speaker 1: top down and bottom up look at big banks, their

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Speaker 1: balance sheets and more. Chris Wayland, senior Managing director at

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Speaker 1: the Kroll Bond Rating Agency here in New York City,

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Speaker 1: joins us. Now, Chris, welcome back, Good afternoon, Kathleen. So

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Speaker 1: everybody passed, though Morgan Stanley trailed the rest of Wall

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Speaker 1: Street in a key measure of leverage. What do you

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Speaker 1: see in these results? Well, it's hard to say that

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Speaker 1: FED doesn't give us enough information to really assess the

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Speaker 1: tests in a, you know, in an objective sort of way.

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Speaker 1: It's good that they all passed because of the obvious cost.

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Speaker 1: You know, if you fail, you're not allowed to return

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Speaker 1: money to shareholders, You're not allowed to pay the dividends

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Speaker 1: you want. So it has a big impact on the

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Speaker 1: equity markets. UM. And really, as we've discussed in the past, Kathleen,

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Speaker 1: you know, bank stress is not about capital. It's about liquidity.

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Speaker 1: That's why we had the crisis, and so these tests

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Speaker 1: are kind of to make us all feel good. But

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Speaker 1: does a bank ever consume capital before it fails. No,

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Speaker 1: So the whole premise of the test is I think

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Speaker 1: a bit misguided. And it goes back to you know,

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Speaker 1: Secretary A. Geitner when he first came up with the

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Speaker 1: idea of stress tests as a way of restoring confidence

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Speaker 1: in banks, UM, it had an obvious political uh utility.

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Speaker 1: But the continuing stress tests that we go through each year,

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Speaker 1: you know, frankly or enormous drain on banks. The senior

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Speaker 1: management has to spend months modeling economic scenarios and a

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Speaker 1: lot of stuff that has nothing to do with running

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Speaker 1: the bank. Uh. And so when you look at these results,

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Speaker 1: you really don't know what to say because the FED

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Speaker 1: doesn't give us enough information to understand the tests. And

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Speaker 1: in particular, you know, true question about Morgan Stanley to

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Speaker 1: understand just why it is that they did less well

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Speaker 1: than the others, you know, since they all passed, right,

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Speaker 1: Chris Whalen has the Federal Reserve in following the Dodd

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Speaker 1: Frank legislation, Have they created this whole other industry within

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Speaker 1: banks that has nothing to do with the banking industry,

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Speaker 1: where the functions that they provide to their customers or

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Speaker 1: their clients. Well, it's certainly a big cost. I mean,

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Speaker 1: it is a lot of additional cost for banks which

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Speaker 1: comes out of the pockets of shareholders. And yes, I

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Speaker 1: agree with the way you characterize. It really has nothing

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Speaker 1: to do with running the bank. I often asked the

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Speaker 1: banks that we rate, who's running the bank while you

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Speaker 1: work on the stress test, because it's just it's board members,

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Speaker 1: senior management and lots of consultants. Well, a way is

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Speaker 1: a heart. I'm looking at our Bloomberg's story by Jesse

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Speaker 1: Hamilton's and Dacan Campbell, and it looks at systemically important bank.

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Speaker 1: So that's well as far will be of a JP Morgan, Goldman, Morgan, Stanley,

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Speaker 1: City State and Bank of New York melot and the

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Speaker 1: regulatory minimum, for example, for a common equity Tier one

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Speaker 1: capital ratio is four and a half percent, and then

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Speaker 1: it shows what the capital ratios are. Wouldn't be pretty

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Speaker 1: easy if you're a big bank to say, oh, here's

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Speaker 1: my capital ratio. Boom if I'm above four and a

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Speaker 1: half percent, am okay, right. But you and I could

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Speaker 1: do a very thorough stress test, Kathleen with the public

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Speaker 1: data in half an hour. We wouldn't need to come

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Speaker 1: up with economic scenarios. We wouldn't have to employ economists

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Speaker 1: and other consultants to work on this for months. Stress

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Speaker 1: testing is about loss absorption. That's all it is. But

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Speaker 1: you know, if you think about it, when a bank fails,

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Speaker 1: the only thing that capital really does is offset losses

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Speaker 1: to the industry, because the industry ultimately backs up one another,

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Speaker 1: joint in severally. That's what the fdi C is. It's

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Speaker 1: a big mutual insurance company and the industry stands behind it.

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Speaker 1: So only if a bank fails do we care about capital.

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Speaker 1: What really matters if the bank is a going concern

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Speaker 1: is liquidity and access to markets and confidence with a

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Speaker 1: capital C that's all it matters. If you don't have confidence,

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Speaker 1: no amount of capital will save you. Chris is part

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Speaker 1: of this confidence building exercise. I understand that banks had

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Speaker 1: to project greater losses than in previous stress tests, including

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Speaker 1: what about a hundred and thirteen billion dollars in trading

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Speaker 1: losses for that that was for the eight largest firms, right, Yes,

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Speaker 1: how did they come up with that number? They're doing

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Speaker 1: is they're trying to throw a severe scenario at the

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Speaker 1: bank and say could you get through such a scenario

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Speaker 1: and still have capital left? Um, we do very similar

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Speaker 1: sorts of tests on banks when we rate them. We

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Speaker 1: look at a moderate scenario and then we look at

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Speaker 1: the crisis and say, how did you do through the crisis?

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Speaker 1: Because that was a big spike in losses. It was

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Speaker 1: enormous for three s four standard deviations. So you know,

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Speaker 1: it's all fine, but it doesn't really tell me as

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Speaker 1: an analyst whether or not a given bank is going

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Speaker 1: to be able to do well in a time when

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Speaker 1: investors get cold feet and run, which is what happened

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Speaker 1: in in in two thousand and eight. And again remember,

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Speaker 1: but it's all about liquidity, it's not about capital. Uh.

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Speaker 1: And with all due respect to my colleagues in the

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Speaker 1: FED and everywhere else, um, you know, capital has become

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Speaker 1: the panacea it's the thing we all grab onto and say,

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Speaker 1: oh good, the banks are safer, But really, market liquidity

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Speaker 1: hasn't recovered. And I think what the FED is doing here,

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Speaker 1: PIM is they're kind of talking their book because with

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Speaker 1: monetary policy, we've distorted markets, We've distorted credit spreads, and

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Speaker 1: I think the FED is a little worried that once

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Speaker 1: we start to see rates go up, you're going to

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Speaker 1: see a lot more volatility. Well, now the Feds talking

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Speaker 1: it's books, but the stress tests are the outcome of

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Speaker 1: the Dodd Frank regulation passed by Congress pick Kathleen the focus.

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Speaker 1: You know, PIM was just talking about trading losses, big concern.

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Speaker 1: I'm much more worried about a lack of revenue for

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Speaker 1: banks from trading. Frankly, yeah, you know, and I get that.

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Speaker 1: I mean, there's a lot of still a lot of

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Speaker 1: controversy over the vocal rule and everything. But it seems

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Speaker 1: to me that the you know, the FED is sort

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Speaker 1: of just going along with what Congress wanted to see,

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Speaker 1: which was something, uh, something more really hitting at the banks.

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Speaker 1: And anytime you turn on the news, Boomberg Radio, Bloomberg television,

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Speaker 1: any Bloomberg outlets read the stories. Someone in Congress is saying, well, well,

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Speaker 1: one of two things. Some are saying you're not strict enough,

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Speaker 1: and that's gonna be a big issue in the campaign.

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Speaker 1: The presidential campaign of thos are saying you're too tough. Well, look,

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Speaker 1: you know, the good news is American banks are very

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Speaker 1: well capitalized compared to banks around the world. Do they

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Speaker 1: have enough capital? It's hard to say, But what I

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Speaker 1: can tell you is that the approach of regulators is

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Speaker 1: basically to punish the victims, particularly the shareholders, and hope

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Speaker 1: that by punishing the victims, they're going to change the

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Speaker 1: behavior of the banks. But we're not punishing the people

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Speaker 1: who caused the crisis. We've already said we won't do that.

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Speaker 1: So it's a very strange approach. You know, you punish

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Speaker 1: everyone but the guilty, and you hope that the innocent

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Speaker 1: they're going to prevent them for being bad in the future. Okay,

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Speaker 1: that's that's a very indirect way of approaching the problem. Right. Well,

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Speaker 1: here's something perhaps even more indirect, if that's possible. Next week,

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Speaker 1: the Federal Reserve will announce the institutions that asked or

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Speaker 1: failed the qualitative part of their exams and haven't the

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Speaker 1: banks complained that the qualitative portion tends to be subjective?

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Speaker 1: Is it subjective? You're you're assessing management, you're assessing internal systems,

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Speaker 1: You're you're trying to discern whether they have good risk management,

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Speaker 1: does management know what risks they're taking? These are qualitative issues,

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Speaker 1: and they're very similar to what we look at in

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Speaker 1: the ratings world. We have the quantitative stuff, the numbers,

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Speaker 1: and the qualitative parts of the most difficult to judge

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Speaker 1: because you're ultimately looking to see whether or not the organization,

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Speaker 1: the people, the systems can prevent risks. And that's that's

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Speaker 1: the tough part. Well, then, uh, let's step back big picture,

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Speaker 1: depending on whoen's the White House and the congressional races. Um,

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Speaker 1: any chance someone would say, you know what, this is

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Speaker 1: just too much work. Why don't we just make it

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Speaker 1: clear to banks that if they don't have enough capital

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Speaker 1: and they don't really listen to their risk management officers

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Speaker 1: and they get in trouble, we are just going to

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Speaker 1: quickly resolve them and do it that way. Would that

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Speaker 1: put the fear of you know, financial regulator, that you know,

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Speaker 1: the fear of the market into them, and you would

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Speaker 1: need all this stuff, well, I suppose I think a

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Speaker 1: better way, Kathleen would be to force in the raise

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Speaker 1: more capital, and that's what we're doing now. Do away

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Speaker 1: with the stress test and simply rely on public data

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Speaker 1: the investors can look at and understand. And then I

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Speaker 1: think put a lot more emphasis on confidence, on avoiding fraud,

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Speaker 1: on avoiding types of events and missteps that cause investors

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Speaker 1: to lose confidence. Because when investors run away from a bank,

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Speaker 1: when they no longer will face a Lehman or a

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Speaker 1: Bear or whomever, right that that that institution can't function,

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Speaker 1: doesn't matter how much capital they have. It really doesn't.

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Speaker 1: At the end of the day, they have to have

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Speaker 1: access to the market, so it's about liquidity. Thank you

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Speaker 1: very much for joining us. Chris Whalen is senior managing

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Speaker 1: director at the prole Bond Rating Agency and the polls

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Speaker 1: are closing in the UK in just a few minutes

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Speaker 1: and we will be covering it next. You're listening to

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Speaker 1: Bloomberg Radio