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A Unified Theory Of The Stress-test Leaks

Okay, so thanks to a final, heroic burst of leaks, we have a pretty good idea of who stands where, stress-test wise: Bank of America, Wells Fargo, and GMAC all need $10-billion-plus increases in common equity, which is just ordinary stock ($34 billion in BofA's case). Citigroup needs another $5 billion--this on top of up to $45 billion in bailout money it's already converting from preferred shares to equity. (That takes what's essentially a loan from the government and turns it into an ownership stake.) At the other end of the spectrum, Goldman Sachs, JP Morgan, American Express, and MetLife (who knew it was even a bank?) supposedly get a clean bill of health.

But that still leaves two huge questions: Where have all the leaks come from? And can we mine them for more about what the government really thinks?

To review: The Financial Times was first to the leak-fest last Friday afternoon, when, amid reports that the stress-test results would be delayed till this evening (contra the original plan to release them Monday), the paper said the reason was that Citigroup and BofA (among others) were disputing the government's findings. The FT added that, under the early stress-test results, Citi would need to raise $5 billion in new capital and BofA would need to convert up to $45 billion in preferred shares to common equity.

What followed was a week-long scramble to ... mostly prove the FT right. On Saturday, both The Wall Street Journal and The New York Times published pieces confirming that the slacker banks were disputing their stress-test results--hence the delay--and that Citi would need to raise "as much as" $10 billion in additional capital. Then, on Wednesday, the Journal and the Times both reported that the BofA number would be about $35 billion, and that it could all be accomplished through conversion (i.e., no fresh capital necessary in principle). Finally, by Wednesday evening, the Citi number was back near $5 billion.

Not surprisingly, theories about the point of the leaks (and their mixed messages) have proliferated. The leaked information was highly sensitive after all--these are numbers that could move stock prices sharply. Anyone passing them to journalists or investors could face serious jail time. Which is why most people seemed to think the leaks had come from the regulators themselves. Paul Krugman suggested the feds were trying to calibrate the stress-test results so they'd be just big enough to be credible, but not a penny higher. (”Would you believe it if we say Citi is fine? OK, what if we say they need $5 billion? Not enough? How about 10?”). Felix Salmon saw the $10 billion Citi leak as a government attempt to set a floor for expectations--once the figure was out, the banks would assume the market wouldn't accept anything less. Over at Naked Capitalism, Yves Smith just threw up her hands and wondered if the government was creating a smoke screen: "Tire out the critics, numb the casual followers, and leave the boosters in firm control of share of mind."

Here's my theory: It was one of the banks, and not the government, that first leaked the reason for the delay and the Citi and BofA numbers to the FT last Friday. Then, amid the news that it was negotiating with banks over the stress-test results, Treasury and/or the Fed decided to push back, leaking the higher Citi number ($10 billion rather than five). The government wanted it known that it wasn't backing down in the face of bank pressure. Finally, beginning Wednesday morning (with the $35 billion Bank of America leak) and continuing throughout the day, the banks began releasing numbers, prefering to do it on their own terms (and with their own spin) rather than risk investor surprise at the official government announcement tonight.

Most of the action unfolds Friday and Saturday. If you read the original FT piece, a couple things strike you: First, it's in the FT. Given the profile of American outlets like the Journal and Times, why would the U.S. government leak to a British paper? That in itself suggests the original leak came from a bank. On top of which, there's the fact that the FT piece reports a $5 billion figure for Citi, while the subsequent Journal and Times pieces say the government had asked Citi to raise $10 billion. The $5 billion sounds like it's been filtered through a banker's optimistic eyes. And when you further consider the coordinated feel (to borrow Felix Salmon's description) of the similar-sounding Journal and Times stories on Saturday, they start to look a lot like a response to an initial leak.

The irony is that the final Citigroup number ended up being close to the initial $5 billion the FT reported, not the $10 billion from the government's pushback stories. But I think that only further proves the original leak came from a banker. Why? The reason we're back to $5 billion is that Citi has raised several billion dollars selling off some subsidiaires, such as its Japanese brokerage business. But, as of Saturday (the date of the pushback stories), the government wasn't yet counting that money toward Citi's total. So the leaking banker, hoping to persuade the government, would have pegged the figure optimistically at $5 billion, while the as-yet unpersuaded regulators would have put it closer to $10 billion. Only this week did the regulators finally concede the point. As the Journal reported yesterday evening, "The shrinking gap reflects Citigroup's successful efforts to persuade the Fed to give it credit for some of its pending capital-raising initiatives."

All of which brings us to the most imoprtant question: What does the pattern of leaks say about what really went on inside Treasury and the Fed? My guess is something like the following: Going into the stress-test homestretch, the mainstream consensus for the amount of additional capital the banks would collectively need was $100-$200 billion (see here). As the stress test results came in, the government realized it was going to be on the low end of that spectrum. Then the original FT leak exacerbated the problem: Now the government wouldn't just end up on the low-end of expectations; it would face the perception it had arrived there after getting rolled by the banks. That inspired the Saturday morning pushback.

But, of course, you can only push back so much before you create anxiety, which forced the government into a bit of a balancing act. At the same time it was flashing its teeth at Citi, the government took great pains to reassure us that the banking system was healthy overall. Hence a reassuring Times story on Monday, featuring a senior administration official who pronounced all the banks solvent, and a generally upbeat Journal story Tuesday, which put the number of banks needing capital at 10, down from the 14 some had expected. Which is to say, the government hoped to estabilsh credibility by demonstrating it was getting tough with individual banks even as the aggregate numbers conveyed systemic soundness.

If I had to guess, I'd say that's going to be the storyline Friday morning, too. By that point, the government will have had a chance to weigh in with reporters a final time, during the official release of the stress-test results tonight. And, if the past week is any indication, it's not shy about getting its story out.

Update: I tweaked some of the wording within an hour of posting for the sake of precision.

--Noam Scheiber