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Bank Stress Tests: Marking On The Curve

Kevin Drum raises some interesting questions about the banking stress tests. It really does sound like the "trophies for all!" mentality that pervades

Kevin Drum raises some interesting questions about the banking stress tests. It really does sound like the "trophies for all!" mentality that pervades elementary education ("Best Smile," anyone?) but of course the consequences will be a bit more important:

This is a peculiar story from the New York Times:

For the last eight weeks, nearly 200 federal examiners have labored inside some of the nation’s biggest banks to determine how those institutions would hold up if the recession deepened.

[...] Regulators say all 19 banks undergoing the exams will pass them. Indeed, they say this is a test that a bank simply will not fail: if the examiners determine that a bank needs “exceptional assistance,” the government, that is, taxpayers, will provide it.

[...] Regulators recognize that for the tests to be credible, not all of the banks can be winners. And it is becoming increasingly clear, industry insiders say, that the government will use its findings to press certain banks to sell troubled assets. The hope is that by cleansing their balance sheets, banks will be able to lure private capital, stabilizing the entire industry.

So what have we learned here? First: all 19 banks will pass. Second: not all the banks can be winners. Third: the ones that pass — but aren't winners! — will be propped up by taxpayers. Fourth: no, they won't be propped up by taxpayers, they'll be forced to sell assets and raise private capital.

Huh? Which is it? If by "pass," regulators merely mean that a bank won't be instantly seized and its management defenestrated, then I guess this makes sense. Awards for all! On the other hand, the prospect of a bank getting a "needs improvement" grade and then successfully selling a big stock issue to raise private capital is just fanciful. Even banks that pass with flying colors will have trouble doing that.

Another part of the story is this:

WASHINGTON (Reuters) - The U.S. Treasury Department is asking banks not to mention the regulatory "stress tests" as part of their first-quarter earnings results, according to a source familiar with government discussions.

Many of the top 19 U.S. banks who are undergoing regulatory stress tests have already completed internal versions of the examinations, which are designed to determine their capital needs under more adverse economic conditions.

However, the banks do not yet know the results of the government's version of the assessment, the source said.

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