WEBVTT - Kroll's Whalen Sees Fed's Bank Stress Tests as Miguided (Audio)

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

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<v Speaker 1>taking Stock with Pim Box and Kathleen Hayes on Bloomberg Radio.

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<v Speaker 1>It's past failed. But the feder Reserves stress test either

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<v Speaker 1>you have enough capital with standished severe economic shock or

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

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<v Speaker 1>results on the latest dress test just announced by the

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<v Speaker 1>Federal Reserve with a man who is known for his

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<v Speaker 1>top down and bottom up look at big banks, their

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<v Speaker 1>balance sheets and more. Chris Wayland, senior Managing director at

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<v Speaker 1>the Kroll Bond Rating Agency here in New York City,

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<v Speaker 1>joins us. Now, Chris, welcome back, Good afternoon, Kathleen. So

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<v Speaker 1>everybody passed, though Morgan Stanley trailed the rest of Wall

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<v Speaker 1>Street in a key measure of leverage. What do you

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

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<v Speaker 1>FED doesn't give us enough information to really assess the

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<v Speaker 1>tests in a, you know, in an objective sort of way.

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

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<v Speaker 1>You know, if you fail, you're not allowed to return

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<v Speaker 1>money to shareholders, You're not allowed to pay the dividends

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<v Speaker 1>you want. So it has a big impact on the

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

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

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<v Speaker 1>That's why we had the crisis, and so these tests

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<v Speaker 1>are kind of to make us all feel good. But

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<v Speaker 1>does a bank ever consume capital before it fails. No,

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<v Speaker 1>So the whole premise of the test is I think

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<v Speaker 1>a bit misguided. And it goes back to you know,

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<v Speaker 1>Secretary A. Geitner when he first came up with the

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<v Speaker 1>idea of stress tests as a way of restoring confidence

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<v Speaker 1>in banks, UM, it had an obvious political uh utility.

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<v Speaker 1>But the continuing stress tests that we go through each year,

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<v Speaker 1>you know, frankly or enormous drain on banks. The senior

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<v Speaker 1>management has to spend months modeling economic scenarios and a

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<v Speaker 1>lot of stuff that has nothing to do with running

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<v Speaker 1>the bank. Uh. And so when you look at these results,

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<v Speaker 1>you really don't know what to say because the FED

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<v Speaker 1>doesn't give us enough information to understand the tests. And

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<v Speaker 1>in particular, you know, true question about Morgan Stanley to

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<v Speaker 1>understand just why it is that they did less well

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<v Speaker 1>than the others, you know, since they all passed, right,

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<v Speaker 1>Chris Whalen has the Federal Reserve in following the Dodd

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<v Speaker 1>Frank legislation, Have they created this whole other industry within

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<v Speaker 1>banks that has nothing to do with the banking industry,

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<v Speaker 1>where the functions that they provide to their customers or

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

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<v Speaker 1>it is a lot of additional cost for banks which

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<v Speaker 1>comes out of the pockets of shareholders. And yes, I

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<v Speaker 1>agree with the way you characterize. It really has nothing

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<v Speaker 1>to do with running the bank. I often asked the

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<v Speaker 1>banks that we rate, who's running the bank while you

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<v Speaker 1>work on the stress test, because it's just it's board members,

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<v Speaker 1>senior management and lots of consultants. Well, a way is

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

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

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

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<v Speaker 1>City State and Bank of New York melot and the

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<v Speaker 1>regulatory minimum, for example, for a common equity Tier one

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<v Speaker 1>capital ratio is four and a half percent, and then

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<v Speaker 1>it shows what the capital ratios are. Wouldn't be pretty

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

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<v Speaker 1>my capital ratio. Boom if I'm above four and a

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<v Speaker 1>half percent, am okay, right. But you and I could

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<v Speaker 1>do a very thorough stress test, Kathleen with the public

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<v Speaker 1>data in half an hour. We wouldn't need to come

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<v Speaker 1>up with economic scenarios. We wouldn't have to employ economists

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<v Speaker 1>and other consultants to work on this for months. Stress

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<v Speaker 1>testing is about loss absorption. That's all it is. But

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<v Speaker 1>you know, if you think about it, when a bank fails,

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<v Speaker 1>the only thing that capital really does is offset losses

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<v Speaker 1>to the industry, because the industry ultimately backs up one another,

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<v Speaker 1>joint in severally. That's what the fdi C is. It's

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<v Speaker 1>a big mutual insurance company and the industry stands behind it.

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<v Speaker 1>So only if a bank fails do we care about capital.

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<v Speaker 1>What really matters if the bank is a going concern

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<v Speaker 1>is liquidity and access to markets and confidence with a

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

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<v Speaker 1>no amount of capital will save you. Chris is part

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<v Speaker 1>of this confidence building exercise. I understand that banks had

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<v Speaker 1>to project greater losses than in previous stress tests, including

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<v Speaker 1>what about a hundred and thirteen billion dollars in trading

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<v Speaker 1>losses for that that was for the eight largest firms, right, Yes,

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<v Speaker 1>how did they come up with that number? They're doing

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<v Speaker 1>is they're trying to throw a severe scenario at the

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<v Speaker 1>bank and say could you get through such a scenario

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<v Speaker 1>and still have capital left? Um, we do very similar

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<v Speaker 1>sorts of tests on banks when we rate them. We

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<v Speaker 1>look at a moderate scenario and then we look at

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<v Speaker 1>the crisis and say, how did you do through the crisis?

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<v Speaker 1>Because that was a big spike in losses. It was

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<v Speaker 1>enormous for three s four standard deviations. So you know,

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<v Speaker 1>it's all fine, but it doesn't really tell me as

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<v Speaker 1>an analyst whether or not a given bank is going

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<v Speaker 1>to be able to do well in a time when

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<v Speaker 1>investors get cold feet and run, which is what happened

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<v Speaker 1>in in in two thousand and eight. And again remember,

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<v Speaker 1>but it's all about liquidity, it's not about capital. Uh.

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<v Speaker 1>And with all due respect to my colleagues in the

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<v Speaker 1>FED and everywhere else, um, you know, capital has become

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<v Speaker 1>the panacea it's the thing we all grab onto and say,

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<v Speaker 1>oh good, the banks are safer, But really, market liquidity

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

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<v Speaker 1>PIM is they're kind of talking their book because with

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<v Speaker 1>monetary policy, we've distorted markets, We've distorted credit spreads, and

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<v Speaker 1>I think the FED is a little worried that once

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<v Speaker 1>we start to see rates go up, you're going to

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<v Speaker 1>see a lot more volatility. Well, now the Feds talking

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<v Speaker 1>it's books, but the stress tests are the outcome of

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<v Speaker 1>the Dodd Frank regulation passed by Congress pick Kathleen the focus.

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<v Speaker 1>You know, PIM was just talking about trading losses, big concern.

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<v Speaker 1>I'm much more worried about a lack of revenue for

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<v Speaker 1>banks from trading. Frankly, yeah, you know, and I get that.

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<v Speaker 1>I mean, there's a lot of still a lot of

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<v Speaker 1>controversy over the vocal rule and everything. But it seems

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<v Speaker 1>to me that the you know, the FED is sort

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<v Speaker 1>of just going along with what Congress wanted to see,

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<v Speaker 1>which was something, uh, something more really hitting at the banks.

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<v Speaker 1>And anytime you turn on the news, Boomberg Radio, Bloomberg television,

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

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

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<v Speaker 1>and that's gonna be a big issue in the campaign.

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

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<v Speaker 1>you know, the good news is American banks are very

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<v Speaker 1>well capitalized compared to banks around the world. Do they

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

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<v Speaker 1>can tell you is that the approach of regulators is

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<v Speaker 1>basically to punish the victims, particularly the shareholders, and hope

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<v Speaker 1>that by punishing the victims, they're going to change the

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<v Speaker 1>behavior of the banks. But we're not punishing the people

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

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

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<v Speaker 1>everyone but the guilty, and you hope that the innocent

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

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

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

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<v Speaker 1>the Federal Reserve will announce the institutions that asked or

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<v Speaker 1>failed the qualitative part of their exams and haven't the

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<v Speaker 1>banks complained that the qualitative portion tends to be subjective?

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<v Speaker 1>Is it subjective? You're you're assessing management, you're assessing internal systems,

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

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

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<v Speaker 1>and they're very similar to what we look at in

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<v Speaker 1>the ratings world. We have the quantitative stuff, the numbers,

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<v Speaker 1>and the qualitative parts of the most difficult to judge

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

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<v Speaker 1>the people, the systems can prevent risks. And that's that's

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

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

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<v Speaker 1>any chance someone would say, you know what, this is

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<v Speaker 1>just too much work. Why don't we just make it

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<v Speaker 1>clear to banks that if they don't have enough capital

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<v Speaker 1>and they don't really listen to their risk management officers

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<v Speaker 1>and they get in trouble, we are just going to

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<v Speaker 1>quickly resolve them and do it that way. Would that

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<v Speaker 1>put the fear of you know, financial regulator, that you know,

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<v Speaker 1>the fear of the market into them, and you would

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<v Speaker 1>need all this stuff, well, I suppose I think a

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<v Speaker 1>better way, Kathleen would be to force in the raise

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

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<v Speaker 1>with the stress test and simply rely on public data

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<v Speaker 1>the investors can look at and understand. And then I

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<v Speaker 1>think put a lot more emphasis on confidence, on avoiding fraud,

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<v Speaker 1>on avoiding types of events and missteps that cause investors

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<v Speaker 1>to lose confidence. Because when investors run away from a bank,

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<v Speaker 1>when they no longer will face a Lehman or a

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<v Speaker 1>Bear or whomever, right that that that institution can't function,

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<v Speaker 1>doesn't matter how much capital they have. It really doesn't.

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<v Speaker 1>At the end of the day, they have to have

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

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<v Speaker 1>very much for joining us. Chris Whalen is senior managing

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<v Speaker 1>director at the prole Bond Rating Agency and the polls

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<v Speaker 1>are closing in the UK in just a few minutes

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<v Speaker 1>and we will be covering it next. You're listening to

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<v Speaker 1>Bloomberg Radio