Blogs & Comment

The U.S. Banks' Stress Tests, Deconstructed

Circle your calendars: May 7th.
That’s the date the Obama administration will announce the results of its ongoing stress tests of America’s biggest banks. And if major news outlets and Beltway insiders are to be believed, the administration will also throw open the books of the 19 biggest banks, so investors and taxpayers can take a look at the results of their investments. It’s an effort to clarify the state of the banks’ financial health in a move to shore up investor confidenceand, likely, a chance to determine which banks should continue to receive government financing.
Of course, when a government is this involved in the workings of private companies, there’s bound to be unintended consequences.
Frank Micciche is a fellow at Washington, D.C.-based thinktank the New America Foundation; he’s also Director of the Next Social Contract Initiative, an effort to rethink domestic social policy in the U.S. in Obama’s era of change. “The effect is that the strong banks are going to get stronger,” he says, “and the weaker ones well, most likely investor confidence in them will drop.”
Announced in February, the stress tests examine how banks would perform under two different scenarios. The more optimistic scenario puts U.S. GDP growth at -2.1% in 2009 and +2% in 2010; unemployment at 8.4% in 2009 and 8.8% in 2010, and housing values plummeting 14% in ’09 and only 4% in ’10. The darker scenario has U.S. GDP contracting 3.3% this year and only growing half a percentage point in 2010; pegs unemployment at 8.9% in ’09 and 10.3% in ’10, and has housing values dropping 20% this year and 7% the next.
The leadership the administration has shown on this point hasn’t been the best. “Frankly, they didn’t really have much of a plan of how or what they’d release,” Micciche says. Rather than coming in a clear announcement, information about the stress tests and the way the results might be used has been, as Micciche puts it, “dribbling out” from the administration via comments from insiders. “There’s been no official notification. Now we are hearing whenwe’ll be seeing them, but we’re still not getting official word on what will happen.”
The stress tests bring to mind one historical precedent: the first act of Franklin Delano Roosevelt‘s administration, when FDR announced they were closing all the banks for a three-day cooling off period (the first “bank holiday”). The administration said it would re-open only the healthy ones; the goal was to clarify which banks were solvent and which not, in an effort to shore up investor confidence.
Micciche doesn’t think we’re in quite such an urgent situation “the administration will not be closing banks,” he says but the results will likely have a disproportionate impact on investor confidence in those banks remaining standing. Another unfortunate result: it’s not smart business for private enterprises to have their inner workings and strategies exposed in such a public way. What’s more, there likely won’t be enough information for investors to make clear decisions. The result? “The stronger banks will become overconfident and the weaker ones will, however unfairly, lose out,” says Micciche.
But when the government is this involved in the financial sector, such situations are virtually inevitable. What’s more, the recent tea party protests on tax day, and a groundswell of angry taxpayer sentiment across the country, indicate the administration has got to do something to ensure Americans have a better idea of where their money has been going. “Taxpayers are demanding some sort of demonstration of results,” Micciche says. “This provides the government an opportunity to assess what they are investing in, before they decide to invest any further.”