Feds’ Stress Tests Criticized as Politicized PR Effort

Published August 1, 2009

The results of government “stress tests” of banks with assets greater than $100 billion—19 banking organizations in all—have evoked shrugs and skepticism from many experts.

“The ultimate stress test of a bank is its stock price,” said Yaron Brook, president and executive director of the Ayn Rand Center for Individual Rights. “When Citi stock plummeted to under $2 a share, the market was indicating that Citi was probably insolvent. It failed the market stress test.”

Brook added, “The bureaucrats responsible [for the stress tests] are in a far worse position to determine the insolvency of any individual bank than are investors in the marketplace.”

“Talk about a perfect example of the pot calling the kettle black,” said John Tillman, CEO of the Illinois Policy Institute. “The federal government is teetering on the edge of bankruptcy, and yet it’s giving ‘stress tests’ to banks? If the government, which is virtually insolvent, has become our go-to authority on financial management, we’re in deep trouble.”

The test results, released in May, concluded the banks as a whole were viable but 10 of the 19 could collapse in a heightened recession and required, in total, $75 billion of additional capital to prepare for that possibility.

Not a True Evaluation

Richard Bove, a bank analyst at Rochdale Securities, argues the tests were politicized and not thorough enough to evaluate the banks’ fiscal health accurately.

Bove said in an MSNBC interview the stress tests may have been an elaborate attempt to restore faith in the banks without another massive bailout.

“The stress test was done to prove to the public that the banks are in good shape, because the government simply cannot come up with more money to put into the banks,” said Bove. “I think the net effect of it is a sham. It is a political game. And I think that what they have now done is backed themselves into a corner because they have to say which banks are not doing well.”

Attempt to ‘Muddle Through’

Others argue any step away from government takeovers of banks should be praised.

“The stress tests reduced some uncertainty concerning the solvency of the banking system. The tests were reasonable, albeit not as difficult to pass as some critics would have liked,” said Alexander Tabarrok, research director at the Independent Institute. “The most important effect of the stress tests is that they have reduced the call for bank nationalization at the present time—a call that may return if the economy deteriorates even further. The stress tests have thus given the banks and the Obama administration more time to see if the economy recovers and the banks muddle through.”

The tested banks—including Bank of America, J.P. Morgan Chase & Co., Citigroup, Goldman Sachs, and Wells Fargo—constitute about two-thirds of all U.S. bank holding company assets.

Matthew Glans ([email protected]) is legislative specialist in insurance and finance issues for The Heartland Institute.