I haven't written much about the stress tests yet; not too much has actually changed policywise because of them and most analysts have contented themselves with speculation about public relations agendas. It will be much more interesting as the banks announce their reactions to the tests, and specifically how they expect to make up their captial shortfalls. That said, I think Matt Yglesias has the wrong worry here about what might happen if the government took shares of common equity in banks:
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.
I actually doubt that. Charlie Rose asked Tim Geithner how involved with management he would be on Wednesday, and the first thing he said was "If we have have those situations, we will have to make judgments about whether the quality of leadership in those institutions are strong enough so that, again, our interests are met best." That same day, Robert Gibbs refused to rule out management changes at the banks. And the Federal Reserve/Treasury statement says that, as part of the program, "firms will need to review their existing management and Board in order to assure that the leadership of the firm has sufficient expertise and ability to manage the risks presented by the current economic environment and maintain balance sheet capacity sufficient to continue prudent lending to meet the credit needs of the economy."
Before the administration fired GM chief Rick Wagoner, everyone sort of assumed that the president wasn't interested in that kind of step, but then it happened. It's going to be step-by-step process, but those banks who are unable to raise private capital and must turn to the government will probably be seen as having a leadership problem, giving the government all the more incentive in making such a demand. I'm fairly confident will see some changes in leadership at the banks that are identified as the most in need of funding, particularly GMAC, BofA and Citi.
On a related note, Paul Krugman's column today is a rock-solid explanation of what is happening right now around the stress tests, and what the administration hopes to accomplish, warts and all. But the bit at the end where he cites H. Rodgin Cohen to suggest the administration won't be able to push regulatory reform is a bit of a cheap shot. Of course Wall Street insiders want the same system! The question of how to reform the financial sector has different cost incentives for the administration from the question of how aggressively to intervene to promote recovery -- the latter will cost a trillion dollars Congress won't give them, while the former requires political will. While it's too early to know if the administration will succeed at either task, it's hard to read their approach on recovery as indicative of how they will handle regulatory reform. That said, if their work on the cramdown bill is any indicator, be concerned...
-- Tim Fernholz
