Sideways: Fed stress tests – prizes for all (US banks at least)


Jon Macaskill
Published on:

Deutsche Bank’s failure of the recent Federal Reserve stress tests drew attention, but while the regulator was happy to kick the battered European bank while it is down, this was in stark contrast to its treatment of favoured home-town players Goldman Sachs and Morgan Stanley.


Federal Reserve officials invented a brand-new grade that allowed the two firms to avoid failing the test, in the form of the ‘conditional non-objection’. The banks will be allowed to maintain their capital distributions to shareholders at the levels of recent years, despite submitting plans that would have meant that their capital ratios would have fallen below required levels under stressed conditions.

Goldman chief executive Lloyd Blankfein and his counterpart at Morgan Stanley, James Gorman, were able to declare victory of a sort, their stock prices were barely affected and they should find it easier to achieve the return on equity targets that are a key driver of their own remuneration packages.

Federal Reserve vice-chairman Randal Quarles was happy to explain that Goldman and Morgan Stanley kinda sorta passed the test, even though they technically failed, because the long-term effect of US tax cuts will outweigh the impact of the short-term impact on earnings.

“Even with one-time challenges posed by changes to the tax law, the CCAR [capital test] results demonstrate that the largest banks have strong capital levels and, after making their approved capital distributions, would retain their ability to lend even in a severe recession,” he said.

Quarles was installed by the Trump administration as the chief regulatory supervisor at the Federal Reserve last year and appears to come into work every day singing the lyrics of the Lego movie song ‘Everything is awesome’.

His prizes-for-all approach – at least for all US banks – introduces some intriguing opportunities for the firms under his benign supervisory gaze.

Goldman and Morgan Stanley both spend enormous amounts of money on marketing. Goldman increased its spending sharply after it was dubbed the “vampire squid” and suffered years of negative publicity and regulatory scrutiny in the wake of the 2008 crisis.

Luring millennials

More recently it has attempted to lure millennials to its new consumer banking venture and tried to convince investment banking customers that its digital services are somehow superior to almost identical offerings from bigger banks such as JPMorgan.

The nagging suspicion that Goldman’s own shareholders will start to worry that the bank is edging back into risky proprietary dealing has no doubt contributed to the decision to keep marketing spending at elevated levels. The brand must be burnished, even though this can be expensive.

But now Goldman effectively has an opportunity to outsource some of its marketing to the US government. If Quarles can be relied upon to pitch in every so often to say what a wonderful world it is for big US banks, then Goldman and Morgan Stanley can save a little on their marketing spend.

This would have an obvious appeal for Gorman, a dour former management consultant who exudes quiet satisfaction whenever he announces that a decision to reduce headcount and force the remaining staff to work harder has paid off.

Of course, if the outsourcing of bank marketing to US regulators becomes too blatant, there is a risk that shareholders and trading counterparties will start to act on their own fears about what is really happening at the biggest firms.

But for now it seems that Wall Street has what it has always needed: real partnership with the government.