In a Wall Street Journal article this morning, headlined “Fed faulted BofA over its foresight,” Christina Rexrode reported that Bank of America “was chastised” by the Federal Reserve for the quality of its stress test submission to the regulator, “according to people familiar with the matter.”
Bank of America was reportedly told by the Fed that it wasn’t forward-looking enough, and only would react to problems after they were raised by regulators.
“Stress tests” include accounting exercises that simulate the resiliency of a bank’s capital base to hypothetical events that can impair bank asset values and earnings. Bank regulators regulate banks, including bank capital. Theoretically, they regulate capital to improve the stability of the banking system. Other things equal, the more capital relative to assets, the more stable the bank, and the banking system.
But some astute observers have long questioned if the dog is wagging the tail, or the tail wagging the dog, on this one. Going into the 2007-2009 financial crisis, banks proved to be sorely undercapitalized, despite, or perhaps more accurately, because, they were regulated.
A longer story, but a story that is central to our mission at Truth in Accounting. Strictly speaking, banks may not be ‘government’ entities, but public capital effectively stands behind banks given the role of the Fed, the FDIC, and the Treasury Department in serving as sources of support. Bank accounting, and bank capital regulation, are quite appropriately viewed as a form of “government accounting.”
Something just doesn’t smell right about this Wall Street Journal story. Let’s put aside the question how much foresight the Fed can claim to have itself, including the value of its opinions about the foresight of others, in light of the Fed’s sorry forecasting record leading up to the recent severe financial crisis.
The article reports that Bank of America was the only one of the five biggest banks to “not earn an unequivocal approval.”
Granted, the Fed’s concerns could have been more closely centered on the management of the stress tests, not simply the adequacy of capital itself. And these tests are complex, sophisticated exercises, for what that is worth, anyway, and not the simple data you are going see below.
The chart below shows the ratio of shareholder equity to assets for the last three years for J.P. MorganChase, Citigroup, Bank of America, Wells Fargo, and Bank of New York Mellon.
In a sense, we may be talking about a distinction without a difference. Bottom-line, the five largest banks in the United States have only a small sliver (roughly 10%) of capital to assets, in a narrow range looking across those five banks.
One wonders if some of the powers that be want to show that they are on top of things, even if they aren’t.
Here’s a provocative if not cool recent book discussing the role of capital in banking, as a matter of public welfare.