Banks Explode on a $65 Billion Landmine

So much for secrecy.

The banks' stress test results, meant to remain secret until later this afternoon, have been leaked almost in their entirety. At least seven of the 19 banks subjected to the forward-looking test will be required to bolster their capital by a combined $65 billion.

Again, these results aren't official, but here's what has been leaked so far, according to the Wall Street Journal.

Source: The Wall Street Journal.

Word also trickled out that JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), and American Express (NYSE:AXP), among others, passed the test and will be let off scot-free.

Once the results are officially disclosed later today, the banks with capital holes will be given one month to present a plan on how they'll raise the money. They'll then have six months to actually get it done.

How can banks raise capital? They have a few different options:

• Sell assets
• Raise money from private investors
• Convert preferred shares into common capital

The first, selling assets, is simply much easier said than done. For banks required to raise a relatively small amount of money, it's feasible. But for others, it'll either be impossible or extremely inefficient. If beleaguered banks could sell a meaningful amount of assets at levels that didn't constitute giving away the house, they'd already be doing so. Not unlike the issues clogging the broader debt markets, banks will be constrained in selling assets, because there are either no buyers for them, or they could only fetch wildly unimpressive prices in today's market.

This leaves the second two options -- raising money from private investors, or getting it from Uncle Sam -- as the most probable. Now that bank stocks have gone gangbusters over the past eight weeks, tapping the private markets might actually be manageable. Raising money from private markets is obviously preferable to asking Washington for help. Private investors rarely demand Congressional hearings to ask how the money's being spent, and they don't have the power to slap together 90% retroactive taxes when they get annoyed.

That said, we have yet to determines whether the ferocious rally that's sent some bank stocks up several hundred percent is really sustainable. I happen to feel it isn't.

Take Bank of America. Shares soared 17% yesterday -- and another 19% at one point this morning -- on news that it has a capital shortfall equal to more than one-third of its market cap. Some investors will tell you "the uncertainty of how much capital will need to be raised is gone." OK, but now we know what the "certainty" is: It's terrible, and potentially disastrously dilutive. That's reason to send shares back up to where they were before January's bailout?

Besides, where will the $34 billion come from? If the capital comes from preferred stock conversions, what will the conversion price be? How dilutive will that become? No one knows the answers to these questions, but investors seem assured that when the answers come, they'll work out in Wall Street's favor. That's a dangerous place to be.

At any rate, we'll have continuing coverage of the bank stress test results as the info rolls in. Tomorrow morning, we'll have a Fool roundtable discussing the pros and cons of the data, and what it means for your investments going forward.

For related Foolishness:

• This Rally Is Ridiculous
• Will Banks Plummet Tomorrow?
• More Credit Losses Are Coming to America