The wave of common stock issues launched in the wake of the Federal Reserve’s stress tests are good news for U.S. taxpayers. Things might have been even better if the stress tests encouraged even higher common equity capital ratios than they did, but we’re off to a good start.
Since the stress test results were released last week, there have been $19.1 billion dollars in common stock issued or announced. Morgan Stanley and Wells Fargo completed offerings valued at $12.6 billion last week. U.S. Bancorp, Capital One Financial Corp, BB&T, and Key Corp announced $6.5 billion of common stock issues today.
This should make the banks less risky and more willing to lend.
“My research indicates that the regulatory sticks used by the Federal Reserve in the stress tests have done more to reduce systematic risk than the subsidized carrots in terms of the preferred stock injections of the TARP’s Capital Purchase Program,” University of Louisiana at Layfayette economist Linus Wilson tells us. “These increases in these banks’ common equity capital cushions are likely to improve for these banks lending decisions going forward.”
Linus points us toward two of his reserach papers, “Common (Stock) Senses about Risk Shifting and Bank Bailouts” and “Debt Overhang and Bank Bailouts.” The findings of those papers, he tells us, indicate that banks that raise common equity will make better lending decisions and will be more willing to extend credit to worthy borrowers.
While the stress tests were a step in the right direction, they probably did not go far enough. They probably should have encouraged higher common equity capital ratios than they did.