Today, the Congressional Oversight Panel (COP) for the TARP, chaired by Prof. Elizabeth Warren, released a report examining the efficacy of the stress tests that were performed on the nation’s largest banks. One of the panel’s recommendations was that Treasury start working on Stress Test: The Sequel. “We actually make recommendations to do it all over again right now,” Warren told CNBC, citing worsening economic conditions.
It seems a bit too early to tell whether or not the “adverse” economic scenario laid out in the tests was overly optimistic (even though eventually coming to that conclusion is entirely possible), so I don’t know how much there is to learn from another test right now. But I do think it’s worth endorsing COP member Richard Neiman’s proposal to make some form of stress test a “semi-regular” feature of bank regulation:
“I would certainly support that they utilize this on an ad hoc basis, that we encourage institutions to do these tests and report them to the regulators,” Neiman told the Huffington Post. “And we recommend that the Treasury continue to track the economic indicators to make sure they are tracking the assumptions used under the plan, and to the extent that they exceed those assumptions, that we repeat those tests.” While acknowledging that there would be a “resource issue,” Neiman said that continuing the stress tests is like taking your car in for a check-up, even when it seems everything seems to be running okay.
This is particularly important given that the Treasury Department gave 10 banks the go-ahead today to repay $68 billion in TARP funds. This occurred despite data showing that the “pace of prime borrowers going into foreclosure is accelerating,” and “the default rate on commercial mortgages held by U.S. banks may rise to the highest in 17 years,” both of which could spell trouble for bank balance sheets down the road.
It also ties into concerns that the plan for removing the banks’ toxic assets is dead in the water, due to a lack of interest from the banks. Treasury told The American Prospect’s Tim Fernholz that this isn’t the case, but it’s unclear how Treasury plans to get the ball moving when the banks seem perfectly content to just wait out the recession.
But the assets are still sitting there, and some analysts have concluded that “accounting rule changes and rosy assumptions are making [the banks] look healthier than they are.” In light of all this, giving the banking system a periodic checkup that is transparent and easy to understand seems to make complete sense, provided that the tests are designed to actually put the banks through a bit of stress.