The Government’s Learning Curve

Story Highlights:

• The government is drawing up plans to disclose results of the nearly completed bank stress tests.
• This move could be a result of some banks recently announcing intentions to repay funds from the Troubled Asset Relief Program (TARP). Banks unable to pay back funds may be regarded as too undercapitalized to do so, raising speculation about which financial institutions are healthy.
• The government's hoping details from the stress test results will quell such speculation. But the results will also expose which banks are relatively weaker.
• Exposing weaker banks could drive down investor confidence in those banks, but the Fed and Treasury will no doubt stabilize weak banks or make other viable arrangements as needed.
• The key is how heavy-handed—or not—the government will be with the stress tests.

(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)
_______________________________________________________________________

The Treasury introduced the idea of stress tests for banks in February, but details since have been murky. Now, it appears some light will finally shine through—the government is drawing up plans to disclose results of the nearly completed stress tests. But the findings could call into question some banks' relative health.

The government's move to add transparency to stress tests may have been forced by some banks recently announcing intentions to repay funds from the Troubled Asset Relief Program (TARP). TARP was always a bit deceptive—both healthy and weak banks were encouraged to accept TARP funds to mask which banks truly needed government support. However, TARP imposed heavy-handed restrictions on recipient banks, and healthy banks with the wherewithal are now requesting to pay back funds. Banks unable to pay back the funds may be regarded as too undercapitalized to do so. This could stir speculation about which financial institutions are healthy and possibly put downward pressure on certain institutions guessed to be weak—potentially undermining the government's efforts to stabilize the banking system.

The government's hoping details from the stress test results will quell such speculation. But the results will also expose which banks are relatively weaker (ironically revealing what TARP tried to cover up). Runs on the relatively weak banks are unlikely since the government is insuring all deposits. However, exposing weaker banks could drive down investor confidence in those banks. (Though arguably, the market's already done that since Citigroup's market capitalization, $21.9 billion, is now less than half Goldman Sachs's at $56.0 billion.) Still, the Fed and Treasury, having already voiced firm commitment to support the banking system, will no doubt stabilize weak banks or make other viable arrangements as needed.

There's still plenty of vagueness tied to the stress tests. But rather than focus on which banks are judged relatively weaker, the key is how heavy-handed or not the government will be. For one, the government officials have yet to clarify what the results will mean for banks. The administration's already noted no bank will "fail" the tests, but it may force weaker banks to raise more capital or something else. If the feds have learned, they will not force banks to do things they wouldn't otherwise do. If they've failed to learn, a heavy hand with the stress tests would be a negative indicator for the administration's ability to learn from prior mistakes (both its own and the prior administration's).

There's no question some banks are weaker than others right now. As in any industry, there are strong and weak firms—this shouldn't alarm. Instead, what warrants caution is how apt a pupil the government proves to be.