The stress tests have worked in one sense. They have produced a credible estimate of the likely losses banks will face. But the second part of the test—establishing a buffer big enough to allow banks to absorb those losses and command confidence without state support—looks to have been fudged. It is still hard to imagine the banking system being able to stand on its own two feet without explicit state guarantees of debt issuance and the implicit understanding that the government would step in again. As Mr Geithner admitted, we are only in the "early stages of repair." The mechanics should keep their spanners at the ready.
---"Stresses and strains," The Economist (5.08.09)
If you are still trying to understand what the so-called "stress test" of major US banks is all about, trying to put the various pieces together, a recent edition of The Economist adds another piece or two along with their concerns. It is worth the read. But they miss or fail to acknowledge the principal reason for the stress tests: to raise public trust and confidence in the financial system, and investor optimism about investing in the financial sector. And that appears to have been a success. Financial stocks along with the stock market generally have risen notably.
But I too have heard and read the concerns about whether one or the other of the assumptions was demanding or distressed enough. I have seen Treasury Secretary Tim Geithner's frustrated pleas that the assumptions of the stress tests are fully adequate for the banks, the government, and the public to understand the general condition of various major banks--and what a reasonable level of capital might be for each. But what is most important to the banks is not whether the stress test assumptions on needed capital are perfectly accurate or would provide a conservative enough cushion. No one knows better than the banks themselves what their loan losses could potentially be. And they know just as well the level of capital that will likely be required to absorb those losses.
No, what the banks need is a more trusting and confident investor public, an investor public ready to see the market situation today as an investment opportunity. And if the government assumptions and findings are roughly in the ball park, then that is likely all the "street" is reasonably looking for. Then the banks will again be able to access the public markets to raise needed capital, as many of them are now starting to do.
This has always been what the stess tests were about. And does anyone doubt that the government will still be there to guarantee the debt of any too-big-to-fail bank that may not be able to successfully raise enough capital independently? Fed Chairman Bernanke and Secretary Geithner's recent comments and written disclosures make clear that they will be. So far, so good.
http://www.economist.com/daily/news/displaystory.cfm?story_id=13635450&fsrc=nwl
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