Your Daily Profit
May 5, 2009 

*****Stress Tests are a Joke
*****The New Bailout
*****How to Profit from Toxic Assets

Fellow investor,

The Treasury’s stress tests are now, officially, a joke …

First, the outcome looked as if all banks would need to raise capital. Then it was reduced to just three. Now it “might” be “about 10” of the 16 banks subjected to the Treasury’s toothless stress tests that may need to raise additional capital to withstand further weakness in the economy.

And the report isn’t even supposed to be out until Thursday. The Obama administration is doing its level best to make sure the market is perfectly prepared for the results of the stress tests. 

While it’s probably wise to consider the impact of the stress tests on the financial markets, I can’t say I approve of rigging the tests to achieve a preferred outcome.

*****Bloomberg reports that financial stocks made their biggest gains in a month yesterday on “optimism about the tests.”

That “optimism” is better described as the realization that the stress tests are fundamentally flawed and the government is prepared to handle the capital issue by letting the banks convert the preferred stock the government owns from TARP loans into common stock.

So basically, the government is saying that banks don’t have to repay TARP loans. The banks can just issue more stock. It’s appropriate that shareholders should bear the risk here. It’s completely inappropriate that taxpayers have to accept bank stock in lieu of cash.

This is really just another bailout.

Converting preferred shares to common stock gives the banks a convenient way top boost “tangible common equity.” It’s basically an accounting trick. But since there’s only $110 billion left in TARP, and Congress almost certainly won’t approve any more funds, it’s a convenient solution.

*****The stress tests are supposed to establish a bank’s viability if the economy gets worse. But apparently the worst-case scenarios that underpin the stress test are nowhere near worst-case.

For instance, for the current period, regulators reportedly used 7.9% unemployment. Current unemployment is 8.1%. For 2010, the stress tests use 10.3% unemployment. But at current rates, unemployment will hit 10.3% this year, not next year.

Of course, it could be a moot point if the economy improves. But what if things do get worse? Geithner is playing a dangerous game here.

*****Right now, the toxic asset plan (PPIP) hasn’t been getting much discussion. But this plan, complete with loans from the Fed, is another way banks can raise money. And it would be much better for the economy.

Our analysis shows that some publicly traded private equity groups could make tremendous profits  by participating in the Public-Private Investment Program. Our top “toxic asset” recommendation is already up 18%. To get my full report in the subject click HERE.

That’s it for today, I’ll talk to you tomorrow.

Ian Wyatt
Editor
Daily Profit

P.S. Quite a few readers have recently asked about options trading and a couple of you specifically asked about options on banks undergoing the recent "stress tests". And you know those results come out on Thursday. I recently interviewed options expert Bryan Bottarelli from Bottarelli research on what he sees as the best options trading opportunities going forward. Click this link to find out more about his service and how investors can make profits from options trading.