Chris Whalen, managing director of Institutional Risk Analytics, says results from the upcoming government stress tests are more about public posturing by the government than getting to the bottom of the economic crisis. Whalen, who has worked as an investment banker and research analyst for years, has not been shy about expressing his bearish views on Citigroup ( C) and AIG ( AIG). His company already has released its own bank grading system ahead of the government's bank stress tests and currently advises customers that are looking to acquire banks. Whalen spoke with TheStreet.com last week about the bank stress tests. TheStreet.com: We've got some bank stress tests, what is going to be the effect on our new bank holding companies? Whalen: The point of the stress test is political. It's about building a narrative so that they can explain to everybody what's going on. It's also about buying time. My sense is that the stress tests are going to go like this. Most banks will pass. The Treasury will indicate that some need more capital and they will put more capital into them. But I think if we're gonna be more credible, a couple of banks will have to fail. The whole point of having a test is that some people pass and some people fail.
Don't you think they are kinda cooked? They don't want to come out and say this bank is in trouble because then there will be a run on the bank. Well, that's right. In a sense they've painted themselves into a corner. The Treasury, Barney Frank, everybody said, well, we have to have transparency. We're gonna reveal the results of the stress test, but the reality is the bank regulators never say anything about a specific institution unless it fails. So we have this conundrum whereby the regulators are apparently going to tell us something on the fourth of May that relates to how these banks did on their stress test, but I can't see how that's going to be beneficial. Because if you say JPMorgan ( JPM) is good and Citigroup is bad, then we're gonna have a run on Citi that day. The naiveté and lack of experience that's evident in the Treasury and the White House with respect to bank supervision is such that they don't realize that regulators never commented publicly about the soundness of a bank.
Right, that used to be the big secret -- the discount window, they never said who went to the discount window. It was very hush-hush. But now we're being transparent so we have an issue of worrying about panic. Let' stalk about failures. Citi, GMAC (the finance arm part-owned by General Motors ( GM)). GMAC is now a bank holding company, right? It's got an operating loss, parent's got an operating loss. What do we say? I think what it really comes down to is this: The first part of the year, the first quarter was still about recognition of losses, the rest of this year is going to be about taking losses and we're not going to be able to fudge these issues any more. The government is trying to manage this process, buy time, build expectations -- all those things -- which is fine, but at some point we're going to have to get the knife out and do what's right. Who's going to have the biggest losses? Well, Citi clearly among the top bank holding companies if you look at our projections for loss rates. They're in the hundreds of billions of dollars, which means we're going to replace their capital a couple of times. The other big banks aren't quite as bad. But if the economy continues to deteriorate -- and I think that's the case -- then all of them are going to need more capital. What about GE (GE)? That's right, and the same thing goes there. When you see real estate companies filing for bankruptcy because they can't roll their portfolios at any price -- there's just no credit available -- ask yourself how that's going to impact the credit quality of these large bank holding companies, and clearly it will. It will clearly impact GE and their financial services side, leasing....The enthusiasm and euphoria we see in the equity markets right now is, I think, a little misplaced.
More bad news from the banks? Yeah, real bad news. Not mark-to-market, it's coming bad news, but real bad news. We're-charging-it-off, we're-selling-it-and-taking-the-loss kind of bad news. And that's different. That's the fundamental difference between what we've been through and what we're going to go through in the next couple of quarters.