Sunday, May 31, 2009

Financial Markets and Economic Crash, The Next Leg Down Will be Worse

Collapsing home prices and credit markets continue to put downward pressure on consumer spending, forcing the Federal Reserve to take even more radical action to revive the economy. Last week, Fed chief Ben Bernanke raised the prospect of further monetizing the debt by purchasing more than the $1.75 trillion of Treasuries and mortgage-backed securities (MBS) already committed. The announcement sent shock-waves through the currency markets where skittish traders have joined doomsayers in predicting tough times ahead for the dollar.

Foreign central banks have been gobbling up US debt at an impressive pace, adding another $60 billion in the last three weeks alone. That's more than enough to cover the current account deficit and put the greenback on solid ground for the time-being. But with fiscal deficits ballooning to $3 trillion in the next year alone, dwindling foreign investment won't be enough to keep the dollar afloat. Bernanke will be forced to either raise interest rates or let the dollar fall hard.

Export-led nations are looking for an edge to revive flagging sales by keeping their currencies undervalued. But the strong dollar is making it harder for Bernanke to engineer a recovery. He'd like nothing more than to see the dollar tumble and reset at a lower rate. That would reduce the debt-load for homeowners and businesses and send consumers racing back to the shopping malls and auto showrooms. Perception management is a big part of stimulating the economy.

That's why the financial media has been air-brushing articles that focus on deflation and shifting the attention to inflation. It's an effort to kick-start consumer spending by convincing people that their money will be worth less in the future. But deflation is still enemy number one. Rising unemployment, crashing home prices, vanishing equity and tighter credit; these are all signs of entrenched deflation.

Bernanke faces three main challenges to put the economy back on track. He must remove the hundreds of billions in toxic assets from the banks balance sheets, reignite consumer spending to offset the sharp decline in aggregate demand, and fix the wholesale credit-mechanism that provides 40 percent of the credit to the broader economy. Treasury Secretary Timothy Geithner has taken over the distribution of the remaining TARP funds, and created a new program, the Public-Private Investment Partnership (PPIP), for purchasing toxic mortgage-backed assets.

The PPIP will provide up to 94 percent "non-recourse" government loans for up to $1 trillion of assets which are worth less than half of their original value at today's prices. The Treasury's plan is an attempt to keep asset prices artificially high so that the losses will not be realized until they've been shifted onto the taxpayer. Here's how John Hussman of Hussman Funds summed up Geithner's PPIP:

"From early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount - the remainder being "non-recourse" financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid.

This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficiently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.

Make no mistake - we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own.

All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans." (John Hussman, "The Fed and Treasury - Putting off Hard Choices with Easy Money, and Probable Chaos,

The second part of the Fed's plan is to fix the wholesale credit-mechanism, which means restoring the securitization markets where pools of loans are transformed into securities and sold to investors. Until Bernanke is able to lure investors back into purchasing high-risk debt-instruments comprised of student loans, mortgage securities, auto loans and credit card debt, the credit markets will continue sputter and growth will be flat.

Structured-debt creates the asset base which is leveraged though traditional loans or complex derivatives. Credit expansion maximizes profit, inflates asset prices and establishes the structural framework for shifting wealth to financial institutions via speculative asset bubbles. This is the basic financial model that US banks and financial institutions hope to export to the rest of the industrial world to ensure a greater portion of global wealth for themselves and a stronger grip on the political process.

Bernanke's Term Asset-backed Securities Loan Facility (TALF) provides up to $1 trillion in non recourse loans to financial institutions willing to buy AAA-rated debt-instruments backed by consumer and small business loans. So far, the response has been tepid at best. For all practical purposes, the market is still frozen. Bernanke knows that there will be no recovery unless the credit markets are functioning properly.

He also knows that the TALF won't succeed unless he provides guarantees for the underlying collateral, which is loans that were made to applicants who have no means for paying them back. Bernanke's guarantees will cost the taxpayer billions of dollars without any assurance that his plan will even work. It's a complete fiasco.

From the Federal Reserve Bank of San Francisco Economic Letter, "US Household Deleveraging and Future consumption Growth" by Reuven Glick and Kevin J. Lansing:

"More than 20 years ago, economist Hyman Minsky (1986) proposed a "financial instability hypothesis." He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions.

Until recently, U.S. households were accumulating debt at a rapid pace, allowing consumption to grow faster than income. An environment of easy credit facilitated this process, fueled further by rising prices of stocks and housing, which provided collateral for even more borrowing. The value of that collateral has since dropped dramatically, leaving many households in a precarious financial position, particularly in light of economic uncertainty that threatens their jobs.

Going forward, it seems probable that many U.S. households will reduce their debt. If accomplished through increased saving, the deleveraging process could result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates. Alternatively, if accomplished through some form of default on existing debt, such as real estate short sales, foreclosures, or bankruptcy, deleveraging could involve significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores.

Moreover, this form of deleveraging would simply shift the problem onto banks that hold these loans as assets on their balance sheets. Either way, the process of household deleveraging will not be painless. (The Federal Reserve Bank of San Francisco Economic Letter, "US Household Deleveraging and Future consumption Growth" by Reuven Glick and Kevin J. Lansing)

The economy is in the grip of deflation. Commercial banks are stockpiling excess reserves (more than $850 billion in less than a year) to prepare for future downgrades, write-offs, defaults and foreclosures. That's deflation. Consumers are cutting back on discretionary spending; driving, eating out, shopping, vacations, hotels, air travel. More deflation. Businesses are laying off employees, slashing inventory, abandoning plans for expansion or reinvestment.

More deflation. Banks are trimming credit lines, calling in loans and raising standards for mortgages, credit cards and commercial real estate. Still more deflation. Bernanke has opened the liquidity valves to full-blast, but consumers are backing off; they're too mired in debt to borrow, so the money sits idle in bank vaults while the economy continues to slump.

In an environment where businesses and consumers are rebuilding their balance sheets and paying off debt, there's only one option; inflation. Bernanke will keep interest rates will stay low while increasing monetary and fiscal stimulus. The ocean of red ink will continue to rise. Still, the systemwide contraction will persist despite the Fed's multi-trillion dollar lending programs, quantitative easing (QE) and Treasury buybacks.

The "Great Unwind" is irreversible; the era of limitless credit expansion is over. David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, believes that the equities markets have undergone a "gargantuan short-cover rally" and that stocks will retest the March 9th low, which was a 12 year low for the S&P 500 Index. Rosenberg said he doesn't expect the economy to recover in the second half of the year.

"I'm seeing no revival of consumer spending in the second quarter," Rosenberg said. (Bloomberg). The conditions that supported the explosive growth of the last decade no longer exist. The credit markets are in a shambles, the banking system is hanging by a thread, and the consumer is out of gas. Traders are clinging to the slim hope that the worst is over, but they could be mistaken. There's probably another leg down and it will be more vicious than the last.

By Mike Whitney

Thursday, May 28, 2009

This is Not a Bull Market: Stocks Are Not Up, and They’re Headed Even Lower

How do you measure wealth generation?

1) Average annual gains?
2) Gains relative to an underlying index (the S&P 500)?
3) Gains relative to inflation?

Of these three, the last is the only real means of gauging wealth creation or destruction. Commentators have been going bananas over the fact that stocks are up 20%+ since their bottom of 666. No one mentions that this rally may actually be induced by the Federal Reserve pumping trillions of dollars into the financial system.

Similarly, no one mentions that adjusted for inflation, stocks are still WAY down from their peak during the Tech bubble. As you can see, stocks entered a bear market in earnest following the Tech Crash. Yes, in number or nominal terms, the Dow has risen. But you have to remember the dollar lost roughly a third of its value from 2001 to today.

Measuring stocks or anything in dollars between now and then was like measuring with a ruler that was continually shrinking. Also, bear in mind that the above chart is using the Government’s phony measure of inflation: the Consumer Price Index [CPI] which DOESN’T include food or energy prices. Using accurate inflationary data, stocks are down even more in real terms.

My main point is this: inflation is an ever-present reality in the post WWII era. Investors need to be protecting themselves from this beast at all costs. You can do this by:
  • Buying gold
  • Buying commodities or real assets
  • Buying companies that can offset inflationary costs by raising the price of their products

I suggest having some money in all three. It’s the only certain way to protect your wealth from inflation. The Feds are cooking up an inflationary storm of epic proportions, pumping TRILLIONS of dollars into the financial system. Stocks may rally like a rocket-ship from here. But in real terms they’re still tanking. After all, if the Dow hits 30,000, but you’re celebrating by drinking a $150.00 coke… are you really any richer?

Article from Seeking (Sorry for not posting it so many days. Having holiday in China)

Monday, May 18, 2009

Soros, The World's Most Influential Investor by Robert Slater

The subtitle to this book on George Soros, I believe, should be “What Makes George Run?” after the title to a novel originally published in 1942. Slater does a good job presenting his subject in an easy to read and interesting biography. Yet, the book seems incomplete because a question still remains as to why Soros does what he does. It is not so much that he is an investor and a very successful one. It is why he seems driven to be a philosopher, a philanthropist, and a political mover and shaker.

As one critic remarked about the subject of the novel just mentioned, he is running “always thinking satisfaction is just around the bend.” It is like Soros has never found a way to justify his existence and so must continually search for ways to prove himself worthy. Over and over he is described as an extremely self-confident man. Yet the things he does indicate a need for something more, something that will ultimately give him satisfaction, something that will give him peace.

Soros is successful. He generously shares his wealth. He wants to do good things and contribute to good government. He wants to be known as a thinker. These are all commendable things and we should certainly hold him in respect for them. It is just that as one reads of his life, as Slater presents it, one comes away feeling that he is not completely comfortable with who he is.

People talk about how both Barack and Michelle Obama seem comfortable with who they are. That is one reason, people contend, that they can project themselves so well to others. They are not trying to be someone they are not. I do not get the same feeling when I read this book about George Soros.

From everything that is public about him, it seems Soros has legitimately earned his fortune. He has worked hard, he has taken risks, and has guessed right more often and in larger amounts that he has guessed wrong. He has set up and led several organizations and has retained talented individuals who have remained loyal and supportive of him. And, he has sustained his position at or near the top of the performance ladder for many years. He remains very, very wealthy.

His secret? Slater tries to get at this, but the best answer he can come up with is that Soros has great intuition. Soros is quoted as saying, “In the final analysis, you must rely on your instincts for survival.” Work hard, read widely, study, study, study…and then…well…? We are told that investing “is a business that doesn’t necessarily lend itself to logical, rational thinking. It’s an intuitive process.”

Soros attempts to provide us with his insight into how markets work and how investors make money. In his major effort to comprehensively explain how he sees the world work, “The Alchemy of Finance”, he describes a world in which all views of the world are “flawed or distorted.” The ‘academic’ models that assume investors have complete information and act rationally with this information are best kept in the academy.

The price of an asset, he contends, is “a result of perceptions that (are) as much the outcome of emotions as of hard data.” Soros uses the term ‘reflexivity’ to describe the connection between these flawed perceptions and the course of events, a connection that, from time-to-time, produces a ‘self-reinforcing factor’ that interacts with ‘underlying trends’ to create wide swings in individual prices or in movements in whole markets. In other words, “Flawed perceptions cause markets ‘to feed on themselves.’”

The Soros effort to provide ‘intellectual’ support to how he views the world falls into the category of economic theories that blame “irrational” explanations for the movement of markets. A recent ‘academic’ presentation of this approach is the book by Robert Shiller and George Akerlof entitled Animal Spirits. Animal spirits, according to Shiller and Akerlof, are related to “noneconomic motives” that are major influences on people making economic decisions: motives like confidence, fairness, corruption and bad faith, money illusion, and stories. Because of these motives, they argue, financial markets will, from time to time, fall into chaos since animal spirits tend to drive the economy sometimes one way and sometimes another causing markets to fluctuate more excessively than if investors had complete information and acted rationally.

To perform well in these markets one must act intuitively and respond on the basis of instinct, attributes that Soros seems to have a plentiful supply of. However, intuition and instinct cannot be taught. They cannot be modeled. Soros, as a thinker and a writer, just does not possess the skills of a Shiller or Akerlof to present such a picture of the world coherently or cogently. And why should we expect this since we are told that Soros has never been more that an average scholar, even in college. Still he tries, for he wants to be a “philosopher.”

This, however, does not seem to satisfy the world famous investor and so he has branched out into ‘good works’ (his philanthropic efforts) and to changing how the world is governed (his efforts to promote liberal causes and open societies). People listen to him. Well, why shouldn’t they? He has lots and lots of money and he has been very willing to give it away to others. I’d listen to him too. It is a small price to pay.

Slater does a good job of relating the events in the life of George Soros: his upbringing in Hungary, his stay in London, his education at the London School of Economics (where he met and interacted with Karl Popper) and his move to New York. He follows Soros through the ups and downs of his investment career, spending a total of three chapters on his “greatest coup,” the “remarkable bet against the pound” in 1992, which “made him a world-famous investor.”

Read this book for the story of the man. Read this book as a history of the period. But, don’t read the book to learn how to invest like George Soros. And don’t read the book to see how all that George Soros has done has led to a contented life.

Friday, May 15, 2009

S&P: Banking Crisis Could Go on for Another 3 or 4 Years

Despite the cautious optimism creeping into the financial markets, in light of what some believe are better-than-expected results from the government stress testing of 19 large banks, Standard & Poor’s Ratings Services believes that “banks are far from a recovery, and the banking crisis has merely entered a new phase.”

…although our analytical time horizon for losses extends only through 2010 … there’s nothing to say that this banking crisis can’t go on for another three or four years. - Tanya Azarchs, managing director at Standard & Poor's

One thing is clear, however: banks will have a tough time surviving unless they have “more capital than even Basel envisioned,” according to Azarchs. The Federal Reserve Board’s stress testing, the results of which were announced May 7, found that 10 of the 19 largest banks need a total of $75 billion in capital to maintain at least 4% of common equity Tier 1 capital if the environment becomes a lot more adverse than experts currently expect.

This compares with Standard & Poor’s assessment of an $18 billion need for these 19 banks on the basis solely of credit stress testing. “Despite the significantly higher capital requirements determined by the Fed’s stress tests as compared to our stress tests, we do not see this as an unmanageable amount, and most management teams of the identified banks promptly issued statements about how they would raise the capital (see “The U.S. Federal Reserve’s Stress Test Results: The Beginning Of The End Or The End Of The Beginning For U.S. Banks?)

Standard & Poor’s completed its own base-case stress testing of banks’ loan portfolios, focusing on credit and earnings risks and their impact on capital adequacy (see What Stress Tests Reveal About U.S. Banks’ Capital Needs.) On May 4, S&P placed ratings on 23 financial institutions on CreditWatch with negative implications. The results, and the rating actions, are wholly independent of the stress testing regulators conducted and indicate widespread, though not necessarily severe, capital needs that could result in downgrades of several notches.

S&P says the Fed’s stress test has been just another step toward the eventual recovery of the global financial industry, but the industry still faces challenges presented by these developing trends:

  • Industry risk is generally creeping higher rather than stabilizing;
  • Losses during this downturn will likely be greater than the industry thought when it began;
  • Franchise stability and market confidence are increasingly critical components of credit;
  • There’s a greater focus on capital adequacy;
  • Government support is now explicit in our ratings for highly systemically important U.S. banks;
  • Hybrid securities appear to be riskier than we thought;
  • The industry structure is changing;
  • Volatility appears to be here to stay;
  • The originate-to-distribute model is being rethought; and
  • Regulation is generally increasing.

Tuesday, May 12, 2009

Is It Time to Sell in May and Come Back Another Day?

Warning shots are being fired.

For the first time in many weeks one of our indicators has delivered a sell signal. Our market leadership model needle is pointed at sell. We also noticed the breakdown on the charts as the NASDAQ crossed under the S&P 500 in terms of performance. The NASDAQ has led the way during this rally up, pay close attention to the lead dog. If it stops pulling the sled, eventually the sled stops moving in that direction.

Despite the markets' continued push upwards, our momentum models lost traction for the 3rd week in a row. For now it is still in buy territory, but one or two soft days and it will be in real danger of pointing at sell too.

Our real fear is that the indexes trade in what we call a triangle pattern (see chart below). We saw this same pattern in our Stock Market Report on June 12th of 2008 and warned investors to get out when the DOW Jones Industrials were at 12,200.

Our call comes a lot earlier in the chart pattern this time which leaves us some wiggle room. We would be very careful in the days ahead and think about pulling some profits off the table.

Investors might be wise to hedge against any fall in stock prices by putting some dollars to work in a reverse ETF. ProShares Short QQQ (PSQ) will return the opposite of the daily performance of the NASDAQ-100 Index®. If the index goes down PSQ goes up. For more excitement, ProShares Ultra Short QQQ (QID) doubles the fun.

A more market neutral trading strategy or hedge would be to buy the ProShares Short QQQ (PSQ) (shorting the NASDAQ) and buying SPDR S&P 500 ETF (SPY) (long the S&P 500). If the market falls and the NASDAQ falls faster than the S&P 500, you will profit. If the markets rise and the S&P 500 outperforms the NASDAQ, you will profit. Earlier we noted that the NASDAQ crossed under the S&P 500 performance wise.

Remember the old saying “go away in May and come back October’s last trading day.” The dog days of summer are here.

Saturday, May 9, 2009

Bursa's Merged Boards To Take Effect Aug 3.

KUALA LUMPUR: Bursa Malaysia’s new board structure is expected to position the local bourse as a competitive capital-raising destination for both local and foreign companies when it comes into effect on Aug 3.

Bursa Malaysia's current Main and Second Boards will be streamlined into a single unified board to be called "Main Market" and the revamped Mesdaq, which will cater companies from all sectors, will be known as "ACE Market".

Securities Commission chairman Datuk Seri Zarinah Anwar said on May 8 the reforms are part of the new fund-raising framework to create an efficient access to capital and investments and transform Bursa Malaysia into a more attractive platform and foreign companies.

Along with the new structure, there is also a significant shift in the regulatory approach with regards to listings and equity fund-raisings. “This new approach to regulation recognises a new environment in terms of diversity of investors, issuers and instruments, and is premised on stronger regulatory capabilities with more diligent surveillance of the market and greater reliance on enforcement.

“It is not about light touch regulation,” she said at the launch of the new fund-raising framework and board structure of Bursa Malaysia. She said to give effect to the new regulatory approach, the SC had released five guidelines on equity, principal adviser, prospectus, asset valuation and structured warrants.

Zarinah said all the guidelines would take effect on August 3, 2009 except for the Structured Warrants Guidelines, which will be effective immediately. She said under the new Equity Guidelines, companies seeking listing under the profit track record test must have an uninterrupted aggregate net profit of at least RM20 million over the past three to five years, with a minimum net profit of RM6 million prior to listing.

However, applicants wishing to list under the market capitalisation test must have a minimum market capitalisation of RM500 million, with no prescribed minimum profit requirement, she added. Zarinah said various flexibilities will also be introduced under the new Equity Guidelines, including the removal of the need for minimum issued and paid-up capital.

She said the Equity Guidelines would include a framework for the listing of Special Purpose Acquisition Companies (SPACs). SPACs are companies with no operations that go public with the intention of merging with or acquiring operating companies or businesses with the proceeds of their IPO.

She said under the new framework, the approval time for listing by SC will be reduced from the current minimum of 74 working days to 60 days. “The SC recognises the need for the corporate sector to have quick access to capital. Hence, enhancing efficiency and shortening the time-to-market have always been a priority for us, but without compromising investor protection,” she added.

Zarinah said under the new framework, the SC's approval under section 212 of the Capital Market and Services Act will only be required for Initial Public Offerings, secondary listings and cross listings and transfer of listings from ACE market to Main Market.

Tuesday, May 5, 2009

Stress Test Leaks: End Game Emerging

It’s a leak free-for-all ahead of the stress test release, and it’s a little difficult to sort out what’s going on. Citigroup and Bank of America are apparently asking the government to conclude that they need no new capital while simultaneously looking to raise upwards of $10 billion each. Meanwhile the administration is preparing to release more detailed information than had been anticipated, but we also have a senior government official saying, “None of these banks are insolvent,” according to the tests.

But it actually seems to me that an endgame is emerging. As Warren Buffett says, the market is increasingly confident in banks not named Citigroup (I’d add Bank of America). The administration probably wants to use the stress tests to sound the all clear for most of the nation’s big banks, helping them to recapitalize primarily from private sources. The tests will show that Bank of America and Citi are “solvent,” but their capital needs will be sufficiently great that private sources of funding will be thinner. And then the fun begins.

Here’s David Leonhardt:

The banks whose reserves are judged insufficient — Bank of America, Citigroup and a few regional banks lead the list of likely suspects — will be given six months to shore up their position, before being required to accept government money. The most obvious ways to do so will be to find new investors willing to buy a stake or to persuade existing owners of preferred stock (which is akin to a loan) to renegotiate their stakes.

Another possibility is that the government may encourage significant cost-cutting. That could lead to layoffs and leave some of the world’s largest companies far smaller than they once were. Last week, Citigroup agreed to sell a brokerage firm to a Japanese financial group, largely to raise capital.

And Francesco Guerrera:

Citi is believed to be considering a plan to convert more than $15bn in trust preferred shares – a hybrid of debt and equity – into common stock. Since trust preferred shares are held by non-government investors, this conversion could enable the authorities to inject further funds into the bank without raising its stake beyond the 36 per cent it has already agreed to buy.

People close to Citi say it would have to force holders of trust preferred shares to convert them into common stock, which ranks below those securities and does not pay a yearly interest rate, by threatening to stop paying interest if they reject the offer.

This looks very similar to the approach to the automakers. Give the problem banks deadlines. Prop them up in the mean time while encouraging them to slim down and squeeze stakeholders, and generally lay the groundwork for something like a bankruptcy (or receivership). The six month deadline could explain why Geithner isn’t that upset about Barney Frank’s slow moving on the regulatory reform bill in Congress (which would include procedures for receivership).

The big question to me is where this leaves PPIP. Hank Paulson eventually gave up on asset purchases after concluding that he didn’t have enough dough to do equity stakes and purchase assets in sufficient quantity to make a difference. I wonder if Geithner isn’t moving the same way, thinking that a clean bill of health will let markets do the recapitalizing of most banks, allowing Treasury to keep its remaining TARP money for the really sick banks.

Saturday, May 2, 2009

US Official: Bank Test Results To Come Thursday

WASHINGTON (AP) -- The Federal Reserve will release "stress tests" results for the biggest U.S. banks on Thursday, according to a government official. Deliberations between banks and regulators about the tests' results pushed back the release date, which initially was expected to be earlier in the week.

In addition to an overall snapshot of the health of the 19 large banks being assessed, the Fed will provide detail about individual banks, according to the official, who spoke on condition of anonymity because of the sensitive nature of the matter. The Fed will describe the resources banks would need to absorb losses on certain types of loans and investments under adverse economic conditions.

Last week, Fed officials said that all 19 banks that underwent stress tests will need to keep an extra buffer of capital reserves beyond what's now required, in case losses continue to mount. That would mean some banks will likely have to raise additional cash. If they do, banks will have up to six months to raise the money from private companies, Federal Reserve Chairman Ben Bernanke has said. If they can't, then the government would provide assistance.

One option for help: allow the government to sharply increase its stakes in banks. That would be done by converting the government's stock in banks from preferred to common shares. It wouldn't require any additional taxpayer money, although it would increase their risks. Another option: having the government make a fresh capital infusion in a bank using taxpayer money from the $700 billion financial bailout pot.

The tests were conducted to help regulators decide whether the banks have sufficient capital -- and the right mix of it -- to withstand any additional shocks to the economy over the next two years. In the tests, the Fed put banks -- including Citigroup, Bank of America and Goldman Sachs -- through two hypothetical scenarios for what might happen to the economy.

One scenario reflects forecasters' current expectations about the recession. It assumes unemployment will reach 8.8 percent in 2010 and house prices will decline by 14 percent this year. The second imagines a worse-than-expected downturn: Unemployment would hit 10.3 percent and house prices would drop 22 percent.

Repairing the U.S. banking system and getting credit flowing more freely to people and businesses is a necessary ingredient for trying to lift the country out of a recession that has dragged on since December 2007. Fallout from the housing, credit and banking crisess -- the worst since the 1930s -- has badly pounded banks. A growing number have failed and others have suffered huge losses.

Last week, the International Monetary Fund estimated that total losses on loans and securities originating in the United States at $2.7 trillion from 2007 to 2010. It also estimated that $275 billion more in capital would be needed to cushion against further losses.