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Ticking Time Bomb: U.S. Banking Industry

BOSTON ( TheStreet) -- Do you hear that ticking sound?

Today it was leaked that the Federal Reserve has requested a "contingency plan" for Bank of America (BAC - Get Report). Supposedly, this includes the possibility of spinning off Merrill Lynch for some extra cash.

Such a request for a plan is extraordinary. It proves that the Fed's so-called "stress tests" are flawed. What is the difference between "if business conditions worsen" and the "adverse scenario" of the stress test?

I will argue that the flawed stress tests have given the public, regulators and the banks a false sense of security. As a result, the banking system is unprepared for a realistic adverse scenario.

First, a brief history refresher. On Oct. 28, 2008, Bank of America received $25 billion of TARP money from the U.S. government. In January 2009, it received another $20 billion. In addition, the government guaranteed over $100 billion of Bank of America assets.

Bank of America has been constantly in the news, especially last month:

Aug. 15: BAC announces it will exit the International Credit Card Business.

Aug. 25: BAC says Warren Buffett's Berkshire Hathaway (BRK.A) will invest $5 billion.

Aug. 29: BAC reports it will sell 13.1 billion shares of China Construction Bank.

Aug. 31: BAC announces it is seeking to sell its mortgage lending division.

There was also an extraordinary public response on Aug. 23 to statements made by a popular blogger that the bank may face a capital shortfall in the $100 billion to $200 billion range.

It is obvious that Bank of America needs to raise capital given its actions. It seems like the Fed has finally realized this. The question is: How much and at what cost?

Unfortunately, it is very difficult to decode the true health of Bank of America -- or any other bank.

Let's consider some of these transactions.

Card business

Bank of America announced the sale of the international credit card business. While most understood the sale of European, Spanish and U.K. units, it was surprising that BAC sold the Canadian unit (which was low risk and within BAC's geography). This signaled to the market that potentially drastic steps needed to be taken to increase capital.

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