The Treasury Department unveiled guidelinesÂ (pdf) today for its bank “stress tests” (I have more details in this week’s paper).Â Seems to me the guidelines will put some federal employees â€” namely, the bank regulators â€” in a tough position. Here’s why.
According to Treasury’s guidelines, regulators have to assess the 19 biggest U.S. banks using two economic scenarios. One of them is the “standard” scenario â€” what most economists think will happen to our economy over the next two years. The other is a sort of worst-case scenario.
If banks fail the tests â€” basically if they have too many questionable loans, and not enough capital to cover their expected losses â€” then they have to raise money and make up the difference. They can do this through private investors, or by asking the government for another investment (more TARP money, essentially).
The banks will probably have some trouble raising money through private sources: the economy is in recession, and it’s doubtful that many investors will see Citigroup and Bank of America as a good investment right now.
That leaves the federal government. Treasury has used half of the $700 billion TARP money appropriated by Congress last fall. And in his address to Congress last night, the president said fixing our financial system will probably require more than the remaining $350 billion.Â But Congress is in no mood to pass another bank bailout.
All of this brings us back to the feds conducting these “stress tests.” They’re in an incredibly high-pressure situation. If banks do poorly, Treasury will be forced to ask Congress for more bailout money â€” a political impossibility. But if these tests are overly optimistic about the health of our biggest banks, the financial system won’t get fixed.
Anyone out there working on Treasury’s bank programs? I’d be interested to hear from you.