Politics & Government

Stress test sneak peek: Big banks still threaten economy

Traders work on the floor of the New York Stock Exchange Monday, May 4, 2009. Brightening news about the economy sent investors rushing into stocks Monday and put Wall Street close to break-even for the year. (AP Photo/Richard Drew)
Traders work on the floor of the New York Stock Exchange Monday, May 4, 2009. Brightening news about the economy sent investors rushing into stocks Monday and put Wall Street close to break-even for the year. (AP Photo/Richard Drew) Associated Press

WASHINGTON — The banking sector remains a threat to the broader economy, judging by leaks of results from stress tests on the nation's 19 largest banks ahead of Thursday's official release by federal regulators.

Bank of America must raise almost $34 billion in new capital and Wells Fargo must raise $15 billion. Additionally, Citigroup would need at least another $5 billion in capital and GMAC, the financing arm of General Motors, must raise another $11.5 billion.

For Main Street, the stress tests are more bad news.

The results mean that banks are likely to continue to sit on money to build their balance sheets rather than lend it out amid a downturn that renders consumers and businesses less creditworthy. This lack of credit is a central reason why the economy has sunk.

"I think it's quite clear from the stress tests that we're not quite done with this financial crisis," said Nariman Behravesh, the chief economist for forecaster IHS Global Insight in Lexington, Mass. "The relevance for the economy as a whole is it will make banks more reluctant to make new loans."

Treasury Secretary Timothy Geithner saw it differently.

"What this is designed to do is to make sure there's this additional cushion of extra resources to deal with the uncertainty we face going forward because that will help make sure there's a stronger capacity for lending as we come out of this recovery. And it is very important that again, banks are able to provide the credit recovery requires," Geithner said in an interview with Charlie Rose, broadcast Wednesday night on PBS.

Bank holding companies that reportedly have passed their stress tests and don't need to raise additional capital include J.P. Morgan Chase, insurer MetLife, credit card companies American Express and Capital One Financial, as well as Goldman Sachs and Bank of New York Mellon.

Goldman and Bank of New York each recently issued new bonds without government guarantees, showing that they're viable on their own, which suggests in turn that they soon may be free to return their taxpayer bailout money.

Administration officials leaked the results bit by bit in an apparent effort to manage Wall Street's reaction, and on Wednesday, financial stocks led a late rally, with investors apparently cheering the fact that the results weren't worse. The Dow Jones Industrial Average finished up 101.63 points to 8512.28, the S&P 500 was up 15.73 points to 919.53 and the Nasdaq closed up 4.98 points to 1759.10.

Bank of America and Citigroup saw their share prices rise 17 percent on Wednesday, while shares of several other financial companies saw similar increases.

The stress tests are designed to gauge how banks would perform if the economy were to worsen more than expected. Regulators envisioned, among other things, a default rate of 20 percent of all outstanding credit-card debt and 12 percent on commercial mortgages.

For the broader economy, the stress-test results are a double-edged sword. They point to a banking sector that has adequate capital for today's downturn. And ordering banks to raise even more capital for a hypothetical worsening of the economy helps build investor confidence in them.

"The institutions are well capitalized, and the stress tests provide a roadmap to increasing capital under a worst-case scenario," said Scott Talbott, the senior vice president of government affairs for the Financial Services Roundtable, a trade group for big financial institutions.

The downside is that the stress-test results encourage some banks to lend even less and hoard even more capital.

"I think the stress test is a joke," said Bert Ely, a veteran banking analyst. "All the government has done is confuse matters and create unnecessary anxiety about the state of these individual banks."

Ely also dismissed the rally in financial stocks, noting that bank stocks are simply moving up after falling off a cliff.

"At this point in time, the market seems to be reacting fairly positively, but keep in mind bank stocks have been so beaten down," he said.

Spokesmen for the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. neither confirmed nor denied the stress-test reports. Late Wednesday, however, those agencies and the Office of the Comptroller of the Currency issued a joint statement detailing some ways they measured capital needs in the stress tests. They also issued timetables under which banks will have to build their newly ordered capital buffer.

The timetables give banks until June 8 to present a plan to regulators for how they'd boost their buffer, and to Nov. 9 to implement the plan. Among options available to banks: raising new capital from private sources, difficult in today's economy, and converting preferred shares of stock to common stock, which has dilutes the value of shareholders' stock.

Another option: sell assets such as stakes in foreign banks. The last-ditch option for most banks is tapping a government program that allows them to convert their existing taxpayer bailout money into shares of stock to be owned by the government.

Such a move could result in management changes, much like the recent ousting of GM chief executive Rick Wagoner. Bank of America chief executive Ken Lewis, who recently was stripped of his chairman's position, has been the subject of constant speculation about a government-imposed ousting.

Asked if such changes were forthcoming, White House spokesman Robert Gibbs didn't rule it out, saying that the current and past administrations have insisted on management changes when significant taxpayer stakes are involved.

"We'll have to wait and see what these individual tests bring," Gibbs said Wednesday.


Inter-agency statement on stress tests


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