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Fed Ties to Banks Incite Calls for Change

It recently came out that the directors of 12 regional Federal Reserve Banks have ties with privately held financial institutions and banks. They are either board members or have significant shares in these institutions. This revelation has incited calls to overhaul the policies of the banking establishments as a whole. On Monday, the Wall Street Journal outlined how Stephen Friedman, a Goldman Sachs Group director and the chairman of the New York Federal Reserve, was allowed to hold both positions even after Goldman Sachs became a Fed-regulated bank last September.

Following the revelation, the New York Federal Reserve has faced a lot of criticisms on its corporate-governance practices. Other regional Federal Reserve Banks including those from Dallas and Kansas City had said they wouldn’t have permitted this type of situation to occur.

According to Cam Fine, the chief executive of the Independent Community Bankers in America, no regional Federal Reserve director should be allowed to have connections with a regulated financial establishment. He added that this “should be a very bright line”. The New York Fed is particularly important because a number of the nation’s largest financial institutions are found in New York.

When the Federal Reserve was formed in 1913 by Congress, it required the 12 regional banks to have nine board members. Three will be appointed by the Fed Board in Washington while six will be elected by the local banks. The regional banks are tasked to give recommendations about the Fed’s discount rate and other matters to the Washington office.

Under its rules, three Class C directors, such as Stephen Friedman cannot hold positions at banks that are regulated by the Federal Reserve. But lawyers sought a way around by asking for a waiver of the Fed policy. This allowed Mr. Friedman to continue his role as Fed chairman even as he held on to a large Goldman Sachs stock at the same time.

The Minneapolis Federal Reserve chairman also asked for a similar waiver. John Marvin, the chairman there, holds shares on both Morgan Stanley and Goldman Sachs. There is good news though. Other regional Fed banks have announced they wouldn’t permit such maneuvers. The Dallas Federal Reserve Bank has asked chief executive Myron Ullman to resign from his Pzena Investment Management position before he was allowed into the Fed board.

Washington Fed officials are responding to the call for more transparency. On Tuesday, Ben Bernanke has announced that more details will be revealed about its borrowers. Currently, it is also reviewing the rules for its regional bank directors in the hope that conflicts can be avoided in the future.

Still Unofficial: Citigroup Failed the Stress Test

Citigroup Failed the Stress Test

Making financial news headlines is the still-unofficial results of the stress test. Apparently, Citigroup may need to raise as much as $10 billion in capital in order to comply with the new standards. However, in an interview with the Wall Street Journal, the bank had argued that this may not be necessary. In fact, Citibank is currently conducting its own analysis and is expecting to find that it already has $500 million as capital safety net. But it was reported that because of Citi’s objections, the findings of the bank stress test will be delayed to May 7 which is three days later than the supposed announcement date.

Citigroup Trying to Raise Additional Cash

It is expected that Citigroup may try to get additional capital from private investors instead of the government bailout money. The New-York based bank was already given $52 billion on rescue funds last year. Under the current plan, the government can convert $25 billion of its stake for a 36 percent voting interest. If it decides to convert the remaining $27 billion, Citigroup will need to cede control. This is a scenario no one wants to ponder for the once biggest US bank.

One solution that is being pointed out is to convert $10 billion privately-held securities. It will be added to the pending exchange to bring Citigroup over the threshold required by the Federal Reserve. Other plans include selling “non-core” business such as the Nikko Cordial Securities and the Smith Barney brokerage to free up capital.

How the Stress Test Will Affect the Future Intervention

The government has previously revealed that it will not allow any of the 19 biggest banks that underwent the stress test to collapse. Those that are found to require additional capital, but are unable to acquire it, may be given additional loans. Later, the administration will reveal what “type of investor it will be in companies where it has a stake” according to the Journal.

Undeniably, the results of the stress test will be felt in the entire financial industry. It will play a big role in determining future government intervention in the financial system. After the results are announced, the banks will be given 30 days to present a plan to the government and six months to implement it.

Will the Stress Test Restore Confidence?

Although the government has previously said that distressed banks need to raise additional capital to meet the strict standards of the “stress tests”, the Obama administration also revealed that it is ready to provide help if the banks needed it. Performed on 19 financial firms, the stress test is intended to boost consumer confidence. It is important to take note that the 19 major firms account for half the loans in the United States banking system and it has become a big part in the government’s rescue plan.

Restoring Consumer Confidence

With today’s economic crisis, you, your friends, and your loved ones might be cutting back to save up for any unforeseen circumstance. This causes great damage to the economy if majority of Americans are doing the same thing. The government wants to stop this trend by assuring the public about the relative strength of the financial sector. Once investors and the public are assured that the country’s biggest financial firms are stable, recovery can begin at a faster pace.

The Federal Reserve has already held top-level meetings with bank executives to give them the lowdown about what the status of certain banks will be if the recession got any worse. Senior Fed officials assured the public that they will keep a close eye on banking institutions to ensure that they have sufficient capital to withstand major economic shocks. The results of the stress test will be announced on May 4. Already, its effects are being felt in a positive way. Wall Street is brimming with anticipation and the Dow Jones Industrial rose by 119 points to close at 8,076.

Criticism of the Stress Test

The concept of the stress test has garnered both praise and criticisms from economic experts. Some critics maintained that the stress test may achieve the opposite effect of what the government wanted. The uncertainty that it creates feels on market volatility. In addition, the market may not accept the hypothetical testing as a realistic one.

How the Government Will Help

The philosophy that major financial firms are “too big to fail” seems to be a fundamental one. The Fed can use several tools to improve a bank’s balance sheet including converting Treasury loans into the bank’s common shares of stocks. Another method would be to compel financial institutions to raise more capital from private market to get more money from the bailout fund. If worse comes to worse, the rescue plan may involve a government-backed merger.

What are Bank “Stress Tests”?

When you hear the words “stress test”, a treadmill, a heart monitor, and your next physical probably come to mind.  When you hear the words “stress test” in the news these days, it is actually referring to something else-tests the government is currently performing on America’s “big banks” amidst this financial crisis.

What are bank “stress tests?”

Shortly after officially taking office as President, Obama and his administration decided to perform stress tests on the nation’s struggling banks.  According to an online article published by NPR back in February, these stress tests “are a widely used method of figuring out how strong a bank’s balance sheet is – essentially using computer models based on historical data to judge how it would withstand various hypothetical situations.“  Another term used to describe the stress testing process is called “shocking” the bank’s books.

Which banks are undergoing government-imposed stress tests?

In February of 2009, the government mandated that all U.S. banks with assets of more than $100 billion would be required to undergo stress tests. This brings the grand total to 19 banks.  These tests were designed to ensure that banks could survive, and continue lending, even if the following shifts were to happen in the future:  unemployment rising to above 10 percent and home prices falling by an additional 25 percent.

Why are they being conducted?

The Treasury stated that banks will undergo these stress tests to determine whether they “have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected.” All of the 19 banks being tested are expected to pass the stress test; however, some banks will be rated higher or lower than others.

Implications of making stress test results public

The White House is still deciding whether or not they will make the results of these stress tests available to the public.  Previously, all of the banks receiving bailout money had been considered equally, preventing the more deeply wounded banks from receiving any negative attention.  The Federal Reserve even announced last week that all results must be kept confidential, as financial results like this are rarely made available to the public.  Nevertheless, some within Obama’s administration believe that results need to be released to confirm the validity of the assessments to the American people.

What if a bank fails the stress test?

As citizens affected by the credit crisis on a daily basis across various aspects of life, it is important to ask yourself what you would do if the bank you bank with failed this government-imposed stress test.  According to Treasury officials, the stress test actually “won’t be “pass or fail,” but a question of what level of capital was adequate.” Either way, these “stress tests” should have little, or no affect on the way you bank.