Partying with the Terminally Ill

The American government’s abortive “stress test” for the ailing financial system: Instead of creating hope, it’s confirming their worst expectations. Only Wall Street is celebrating.

Well before the official announcement on Wednesday, significant results of the so-called stress test of America’s 19 largest banks already had already been leaked by the Obama administration. The test was supposed to show which institutions were still struggling and which were beginning to see that famous light at the end of the tunnel. The preliminary results: More than half the financial institutions needed massive injections of capital.

Bank of America appears to be most stressed. The world’s largest lending institution needs fresh capital, to the tune of $34 million – more than three times the already feared estimate. Citigroup seems to be in no better shape. According to reports in Wednesday’s New York Times, the banking giant, recently just barely rescued from bankruptcy, needs $5 billion to $10 billion for its capital stock. The hopes that the stress test (mostly due to its easy-to-meet criteria) would show the financial sector’s condition in a better light than had been reported were dashed. In spite of that, financial institution stocks put on a real show of fireworks on Wednesday. On the New York Stock Exchange, Bank of America’s stock shot up over 17 percent. Citigroup gained over 16 percent, and bank stocks, in general, went up 3.6 percent across the board.

The whole macabre scenario is reminiscent of a dying patient who has just awakened from a coma and decides to throw a party in his hospital room. The doctor suddenly comes in and informs the patient that tests don’t indicate a good prognosis and that he has a long way to go before he’s out of the woods. But the guests absolutely refuse to stop celebrating – a scene from the apocalypse.

According to Bloomberg Financial Services, the Federal Reserve is supporting the banks with injections of capital and guarantees worth $12.8 billion, a total that nearly equals the United States annual gross domestic product. In April, the Fed added new programs worth another $2 billion to help the banks get rid of their toxic assets. At the same time, the reserve banks threw away all inhibitions and have been flooding the markets with enormous amounts of freshly printed dollars; they are creating money backed by nothing and no one. This aggressive, medium-term and extremely risky policy might avoid a financial market collapse by the end of 2009, but only temporarily. It has nothing at all to do with a decontamination of the U.S. banking system.

According to the International Monetary Fund, American financial markets are faced with additional write-downs of at least $750 billion. At the same time, the Basel-based Bank for International Settlements (BIS) which functions as a central bankers’ bank, reports that the total assets of the banking system had shrunk by $31 billion, i.e., that the inflated credit bubble had shrunk by that figure, accordingly. In comparison, the sums the Fed pumped into the system to avoid a collapse seem rather insignificant. British financial analyst, Mike Whitney, sees the easy money policy as serving only to stoke up speculation in the markets once again, with the attendant danger of creating a new bubble. At the same time, this policy has done absolutely nothing to slow the economy’s rate of descent. That’s why we note with astonishment that U.S. stocks have been rising for six straight weeks, gaining an average of 25 to 30 percent in value, at the same time the actual economy remains in deep recession.

The U.S. GDP contracted 6.1 percent during the first quarter of 2009, compared with a year ago. Real estate prices also continue their descent, albeit not quite as rapidly. Independent prognoses predict American homeowners will see another $4 billion decline in property values and will reduce consumption, accordingly. Rising unemployment will also have a negative effect. Since the onset of the crisis, 5 million people have lost their jobs, and the U.S. government, itself, foresees double-digit unemployment in the near future. The combination of 10 percent unemployment and a 10 percent decline in consumer spending in the coming year may be a worst-case scenario for economists, but it is an entirely possible one. The bank stress test assumed much more favorable conditions in their worst-case scenario, a scenario that assumed the worst part of the crisis would be over by year’s end.

That’s an illusion. Recent figures show the United States continues to live far beyond its means. Forty percent of this lifestyle was financed by the sale of worthless assets to foreigners. The foreigners have had their fingers burned, however, so there’s little chance the old system can be revitalized. Because Americans will be forced to live within their means in the future and have already begun saving more of their money and paying off more of their debts, consumption will continue to decline and the economy will continue to decline along with it.

So much for the current bull market.