My Stress Test Concern

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I’m not a huge fan of the general approach to the banking sector that the Obama administration has decided on. But as I’ve said before, I think that ship has sailed. However, I have a specific concern about the implementation going forward from today’s “stress tests.”

As I understand it, some banks will be deemed inadequately capitalized and given time to raise the needed capital. The belief is that for institutions that don’t need that much capital, they’ll be able to raise it from private sources. Those institutions that need a ton of capital—for example, Bank of America—will then be recapitalized by converting the government’s existing preferred shares into common stock. This, in turn, will substantially dilute the value of existing shareholders’ stakes and turn the government into a very large owner of Bank of American stock. But so then what does the government do with that stake? Do we act like a normal large shareholder and start demanding board seats and a voice in the operation of the company? Based on their conduct thus far, my guess is that Obama and his team aren’t going to want to do that. They’ll want to act as basically silent partners in the firm.

But if so, then it’s going to be a very strange firm. The non-passive shareholders are going to be people who’ve already lost the bulk of their investment. And the bank will be operating with a government guarantee. So their incentives will run in the direction of big bets aimed at pumping the bank back up at all costs, even if the odds on the bets are really bad. Alternatively, there could just be no really coherent corporate governance at all since such a huge part of it will be owned by a silent partner government. Then you’d have basically unaccountable managers probably working full time to extract as much wealth out of the enterprise (which will still be a really big and important enterprise) before the party’s over.

Better, I think, to act like a “normal” big institutional shareholder and try to appoint some directors.


Looks like they’ll be firing some managers at a minimum.

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