In every economy, the most important part is the the ability of the bank’s to make loans or keep credit in the system. When the banks have to restrict credit the economy goes in a tailspin, when the banks can give credit the economy has great potential. It is up to the bankers and the regulators to determine how much credit to give and that is a good thing. In 2008 when the housing market collapsed, the banks gave very little credit or the government had to bail them out. The result was at downturn or potential downturn the Fed Reserve sets higher standards for the banks to buy back stock and increase dividends.
In an article by Lanahn Nguyen, Jeannna Smialek, and Peter Eavis of the New York Times News Service, the Federal Reserve has lifted restrictions on the banks ability to buyback stock and increase dividends.
The Fed’s Vice Chair for Supervision Randal Quarles, said the banking system is strongly positioned to support the ongoing recovery.
The Fed was worried about the potential of banks to be in trouble with increased amounts needed for loan losses, however the government’s programs of enhanced unemployment benefits and stimulus payments resulted in the banks not increasing their loan losses. That was a good thing and the Fed believes the biggest banks are safe to leave your money in.
The Fed tests the banks using a hypothetical case of how the banks would fare if a severe global recession happened and global real estate values fell and equity prices on the stock market fell by 55%. The result would be a loss of $470 billion among the top 23 banks with $160 billion from commercial real estate and corporate loans. The bank’s capital ratios would fall to 10.6%, but that is double the lowest required ratio.
Since the announcement, JPMorgan Chase has announced a $30 billion dollar stock buyback over the course of the year.
Linking to dividend paying stocks, it would be wonderful if all industries had an easy stress test to see if the profitable company paying dividends would easily pass the test. You could look to the results and then do all the other important things in your life as you continue to hold the shares for the dividends. For now the best stress test is the approval of the Federal Reserve. When a company buys back its shares the float is less so the Earnings per Share goes higher which results in the share price increase as the stock multiple goes to normal. The total return on your holding remains high.
There are more questions than answers, till the next time – to raising questions.