How Does A Bank ‘Pass’ A Stress Test, Yet Still Require ‘Exceptional Assistance’?

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"How Does A Bank ‘Pass’ A Stress Test, Yet Still Require ‘Exceptional Assistance’?"

ap081015056971.jpgEarlier this week, we questioned whether or not the stress tests that the nation’s biggest banks are undergoing will actually reveal anything we didn’t already know. If early reports from the bank examiners are any indication, the answer is a resounding no. The New York Times reports:

[T]he banking industry, broadly speaking, seems to be in better shape than many people think, officials involved in the examinations say. That is the good news. The bad news is that many of the largest American lenders, despite all those bailouts, probably need to be bailed out again, either by private investors or, more likely, the federal government. [...] 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.

Yves Smith at Naked Capitalism asked, “so did you get that? They all will be declared to pass in some form, no matter how dreadful they really are,” because “if the remedy is putting in more Federal dollars, rather than a receivership, then the fiction that the money is not being wasted must be preserved.”

The Times also laid out the tests’ conditions, confirming that they are not all that stressful. The “adverse” scenario envisioned by the examiners is “unemployment rising to 10.3 percent by next year, home prices falling an additional 22 percent this year, and the economy contracting by 3.3 percent this year and staying flat in 2010.” Unfortunately, this scenario could absolutely come to pass.

If this is indeed the way in which the stress tests play out in the end, then the Obama administration will have missed a golden opportunity to label insolvent banks as such, and thereby justify taking them over and breaking them up. As Nouriel Roubini said yesterday, “the institutions are insolvent. You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail.”

By taking the stress tests seriously, the administration would have had every rationale for doing just that. Instead, it seems that the tests will be used to paper over the banks’ problems, while leaving the door open for further capital infusions.

Update

Andrew Leonard and Yglesias have more.

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