Four Big Banks Fail Fed “Stress Test” – What It Means

Specifically, they looked at the capital structures of 19 major U.S. banks, and tried to predict what would happen to them if the economy went through a rough patch.

The scenario: A theoretical 50 percent drop in stock prices, housing prices falling another 21 percent, a 13 percent unemployment rate, and a sharp recession in Europe.

The result: 15 banks survived the notional crisis – with the Fed dictating “survival” as success in maintaining tier-one capital ratios of at least 5 percent.

The failures included a few giants, though – most notably Citigroup, though it only failed by a very slim margin, falling to 4.9 percent tier one capital in the scenario.

The dog of the bunch was Ally, formerly the financial wing of General Motors. It would collapse to 2.5 percent tier one capital – just half of the Fed’s requirement. Guess who owns it? You do! This company came under the control of the U.S. Treasury Department after the auto bailout of 2010. Yay, team.

Other banks in the doghouse include MetLife (actually a bank holding company, but they’re in the process of changing that), and SunTrust Bank.

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This is actually good news. The Fed seems to have been blindsided by the route of U.S. banks in the 2008-2009 crisis – and obviously the capital structures of so many of our financial institutions were grossly inadequate. Indeed, our investment banking industry – leveraged in some cases by as much as 30 to 1, was nearly wiped out.

The banks are squawking, of course, because the Fed was too mean. They objected to the Fed using a criteria that was more severe than the 2008 crisis itself.

This isn’t Ping Pong, though. The consequences of the failure of banks to maintain adequate capital reserves are severe. The U.S. government will not abide depositors paying the price for bank profligacy – but the resources of the Federal Deposit Insurance Corporation are paper thin compared to the potential liability. The FDIC can afford to take over the odd small bank and make depositors whole, no problem.

But if Citigroup and SunTrust both went under, it would take a lot of smaller players with them – and overwhelm the resources of the FDIC. We were lucky last time. Citi and Bank of America held together, and were even able to buy up the resources of some troubled banks. We were able to have Chase take over Washington Mutual. It may not be so easy next time.

But there is a price to be paid for this kind of caution: Banks will certainly read the tea leaves and work to shore up their tier one capital – at the expense of lending. And our economic recovery depends, in part, on a prudent revival of our credit markets. Less lending means further pressure on home prices, for example.

The Fed is also firing a shot across the bow at any bank considering boosting its dividend payments to shareholders, or for engaging in a share buy-back program. This won’t be great for shares of bank stocks going forward, though it’s not the end of the world – unless all you own are bank stocks.

If that’s the case, though, we need to talk about diversification.

How To Protect Yourself Against High Gas Prices

As we mention in our companion article, when airlines get nervous about future price increases in jet fuel, they take steps to protect themselves. After all, airlines are a narrow-margin business, most of the time (actually, they typically operate at the ragged edge of disaster).

They do this in a number of ways: They buy call options – the right to buy oil in the future at today’s prices. They look at modernizing their fleet. They try to lighten payloads. They make sure their office buildings are insulated, and install timers on the air conditioning!

You can do a lot of these things, too. Sure, not on as grand a scale as a global transportation company might. But there are some steps you can take to hedge your exposure to high oil prices.

Lock in your monthly energy costs

Worried about unexpectedly high heating or air conditioning costs later this year? Talk to your utility company. Many of them will average your monthly bill over the last year, and let you pay that amount every month. Sometimes you’ll come out ahead, and sometimes behind. But at least you won’t be surprised.

Keep Your Car Maintained

If you drive a lot, you can generate noticeable savings from two things: Keeping your tires properly inflated, and keeping your engine tuned up. If you’ve got a four-cylinder engine, and one of your spark plugs isn’t firing, you’ve lost 25 percent of your efficiency right there. If your car struggles to get up a hill, even when you’ve got the thing floored, this may be an issue. Otherwise, you may have a head gasket leak or you’re losing compression from somewhere. Get it checked out before driving season kicks in.

Invest in Oil and Gas

Hey, I’m an investment guy. I was going to mention it sooner or later.

Sure, you’ve got some exposure to the oil industry just by owning the S&P 500 (don’t get me started on Apple having a higher market capitalization than Exxon Mobile).

But stocks tend to fall when gas prices rise. Think of the 1970s, when the Arab oil embargo threw the U.S economy into recession and caused a 50 percent fall in stock prices between 1974 and 1976.

So you might want to “juice” your portfolio a bit with stocks that actually benefit from high oil prices to compensate. I’m not talking speculating – this is a risk management measure, taken to protect yourself.

There are all kinds of ways to do this – from buying limited partnership interests in oil drilling operations to outright ownership of Exxon-Mobile, Shell Oil and British Petroleum.

I’m not a fan of this approach for most people, except those with pretty big investment portfolios. Think, “millions,” not “thousands.”

For the rest of us who work for a living, you might look at buying some shares of exchange-traded funds, or ETFs, that are themselves tied to high oil or gas prices. Examples include the United States Gasoline Fund and the United States Heating Oil Fund (NYSE: UGA and UHN, respectively).

Neither of these funds concentrate on stocks – which are much harder to predict. Exxon Mobile could drive another tanker onto a rock tomorrow and have to pay a gazillion dollars in clean-up costs, negating the reason you bought the stock in the first place. That’s the deal, when you buy individual stocks – you take on all the company risks that can hit you out of nowhere.

These two ETFs, on the other hand, buy futures contracts on the commodities themselves. When fuel prices rise, so does the value of their shares.

So, in theory, when gas prices go up, you’re fine for a while. You can sell off a piece of your investment each month, and cover the higher gas prices. All it costs you is the commission on the purchase (you may need some help filing taxes next year, though, since these ETFs are structured as partnerships.

Other Hedges

Another way to protect yourself is to use a consumer price-hedging service, similar to Tomorrow’s Gas.  This service lets you buy “protection” against oil price spikes for 12 months at a time. If prices rise, each month, Tomorrow’s Gas adds money to your account to compensate. They send you a gas card, which you can use at the gas station of your choice.

If you’re a business owner, and you have a small fleet of vehicles, you can also hedge your exposure by using a service like FuelBank. This service allows you to hedge your exposure not just to gasoline, but also to diesel, jet fuel, marine diesel and aviation gasoline, as well as to natural gas. For $30 bucks, you protect yourself against price increases of more than $1.00 per gallon for up to 50 gallons per month. If fuel prices rise more than $1.00 gallon, they’ll pay you the difference.  You can also buy plans for 100, 200 or 500 gallons per month, too.

There’s an annual fee of $25 per customer, too, but this is regardless of how many vehicles you have in the fleet.

If you drive a lot, I’d suggest using one or more of these strategies. So if gas prices pop to $5 per gallon or more, you don’t have to worry. Better yet, you can brag to your friends.

Butchers vs. Dieticians … Brokers vs. Fiduciaries

Just saw this great YouTube animation:

Fun and educational stuff. Check it out – it is less than three minutes long.