I deleted an earlier post where I had used an overly simplistic calculation method in order to challenge the recently released stress test findings.

Without going into great detail here, suffice it to day that based on PPIP’s 12:1 non-recourse loan leveraging of assets, I imputed a 65% differential between the notional and marketable value of toxic assets to all derivative holdings, citing the capital adequacy shortfall to be in the TRILLIONS. 

I came to this conclusion, partly based on the current state of US physical economic contraction, unemployment, home values, default rates, etc., all despite massive global “quantitative easing”, which would seem to indicate continued volatility in derivative valuations.

I had no idea that regulators had ascertained with such certainty that JP Morgan’s and Goldman Sach’s assets were of impeccable quality, accurately stated and immutable, despite their immense concentration (87 trillion and 30 trillion, respectively) in derivatives, even under adverse economic scenarios.

In fact, Goldman’s position is so well established that they can afford to have a total credit exposure to capital ratio of 1056% and still be adequately capitalized. Bank of America however, with a total credit exposure to capital ratio of 179% needs 34 billion, possibly because their assets are tainted whereas Goldman’s are Golden?

This must be the questionable accounting method to predict capital shortfalls (QAM/PCS) approach.

I say this because because both “Golden Sacks”, with the highest credit exposure ratio in the group at 1056% to capital, and Morgan Stanley, with the lowest credit exposure ratio at 2.5% to capital, were both deemed healthy:

Goldman Sachs Group Inc. (1056%), Morgan Stanley (2.5%), MetLife Inc., JPMorgan (382.3%), Bank of New York Mellon Corp. (223.1%) and American Express Co. were deemed not to need additional funds, the results show (I have added in the percentages from the OCC Q4 ’08 report).

It comes as a surprise to me that there is such a disconnect between this important FDIC regulated measure and the stress test results, and that the two most polar extremes of total credit exposure to capital ratio would both be in the healthy category. In fact, the OCC states in it’s Supervisory Capital Assessment Program FAQs that:

The assessment of capital adequacy considers many factors including: the inherent risks of the institution’s exposures and business activities, the quality of its balance sheet assets and its off balance sheet commitments, the firm’s earning projections, expectations regarding economic conditions and the composition and quality of its capital.

Specific factors supervisors consider include: uncertainty about the potential impact on earnings and capital from current and prospective economic conditions; asset quality and concentrations of credit exposures; the potential for unanticipated losses and declines in asset values; off balance sheet and contingent liabilities (e.g., implicit and explicit liquidity and credit commitments); the composition, level and quality of capital; the ability of the institution to raise additional common stock and other forms of capital in the market; and other risks that are not fully captured in regulatory capital calculations.

Under current rules for bank holding companies, supervisors expect bank holding companies to hold capital above minimum regulatory capital levels, commensurate with the level and nature of the risks to which they are exposed. That amount of capital held in excess of minimum capital requirements should be commensurate with their firms specific risk profiles, and account for all material risks.  

By the way, the FDIC and Fed Reserve limit on credit exposure to a correspondent is 25% unless the bank can demonstrate that its correspondent is at least adequately capitalized and of course they’re ALL adequately capitalized by today’s standards.

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