If More Means Less, Does Less Mean More?

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The Financial Times has reported that America’s top banks need not raise the full amount of capital mandated by the recent “stress tests” if they manage to book higher than expected earnings:

The banks have 28 days to announce their capital-raising plans and until November 9 to implement them. Wells Fargo and other banks that will have to raise capital told the Financial Times that if operating profits were greater than the government’s stress-case forecast for the second and third quarter, they would receive credit for the difference. That, in turn, would reduce the need to raise fresh equity from other sources.

This leeway that the government offered the financial industry went unmentioned in the initial publicity about the results of the stress tests.

Here’s a question worth asking: If the banks book less profit than expected under the stress tests, will they have to raise more capital than what the government mandated?

For example, Citigroup managed to haggle the government down from approximately $35 billion to $5.5 billion for its fund-raising requirements, based on “the future capital-boosting impacts of pending transactions.” What happens if the promised $30 billion difference doesn’t fully materialize? Will Citigroup be forced to raise more capital? Will it be allowed to continue as a weakened, “zombie” bank? Or will the government take more drastic action?

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