Bank stress tests ill-advised, says Legg’s Bill Miller

The government’s stress tests of banks have been shrugged off by the market, Bill Miller, chairman of Legg Mason Capital Management Inc., told the Investment Company Institute today.

The tests are “ill-advised,” he said. The government tests amount to “having banks raise capital pre-emptively when capital is in short supply in order to deal with scenarios that may never happen,” said Mr. Miller, who is also chief investment officer of the Baltimore-based company.

“Every one of the 19 largest banks [being tested by the government] is well-capitalized,” he said.

The government’s requirements will not raise capital since preferred stock will be converted to common stock, Mr. Miller argued.

“I don’t see what difference that makes at all,” he said.

He spoke on a free-flowing panel discussion in which Martin Flanagan, president and chief executive of Invesco Ltd. of Atlanta, asked a series of questions about recent market events.

A financial recovery has begun, “but gingerly,” said Abby Cohen, senior investment strategist at Goldman Sachs & Co. Inc. of New York. However, the recession will “not end all at once,” she said. “This is going to be a protracted recovery period,” Ms. Cohen predicted.

Different sectors of the economy will trough at different times, but the last sector to recover will be labor markets, she said. Policymakers need to focus on that, Ms. Cohen said.

The big drop in retirement savings will change the behavior of workers about to retire, Mr. Miller predicted. “If people work a few years longer, there is no Social Security problem,” he said.

But state and local pensions are badly underfunded, which could affect the municipal bond markets, Ms. Cohen said.

Investors will become more conservative and save more as a result of the losses they have suffered over the past year, Mr. Miller said. “People have expanded the range of outcomes that they previously thought possible,” he said.

Most did people did not foresee that the value of their houses would decline dramatically or that the economy would take such a dramatic downturn.

The market has likely bottomed out, Ms. Cohen and Mr. Miller agreed. He predicted that “the biggest market surprise by the end of the year” will be a 20% to 30% rise in the U.S. equity market.

Ms. Cohen forecasted that the Standard & Poor’s 500 stock index will rise to between 1,000 and 1,050 by yearend, up from a low point of 670 in March.

On another topic, China is moving to become a dominant player in the world economy, investment experts told the Washington-based ICI on Wednesday.

Last year will be remembered “as the year when China became the dominant economic power in the world,” said James Anderson, chief investment officer of Baillie Gifford & Co. of Edinburgh, Scotland.

Chinese bank lending rose 1,000% in 2008, compared with 2007, he said. The Chinese government also provided a better stimulus package than the U.S. government did, Mr. Anderson said. For instance, China invested $486 billion on its railroad system last year, compared with less than $10 billion spent by the United States.

“Going forward, China will take an increasingly important role,” Ms. Cohen said. However, she does not think China will be a dominant power “right away.”