Bailout Oversight Panel: Bank Stress Tests Don’t Go Far Enough

by James Parks, Jun 9, 2009

The federal government’s recent stress tests of the nation’s largest banks generally were well designed, but they did not go far enough or raise some serious concerns. The tests may need to be repeated often, according to a congressional panel overseeing the $700 billion financial bailout.

Testifying before the Joint Economic Committee (JEC) this morning, Congressional Oversight Panel (COP) Chairwoman Elizabeth Warren said the stress tests were based on assumptions about the economic downturn that may be too optimistic. The COP released a new report today that calls for more strenuous and transparent testing of the banks until the current economic crisis is over. 

Warren, a Harvard Law School professor, said the stress tests assumed an average unemployment rate of 8.9 percent this year. Yet the unemployment rate for last month climbed to 9.4 percent, and the annual average is already at 8.5 percent. If the rate keeps rising, as some economists predict, the numbers will eclipse the worst-case scenario used in the tests.

In her opening statement, JEC Chairwoman Rep. Carolyn Maloney (D-N.Y.) said the key to economic recovery depends a great deal on the public’s confidence in the banking system. 

Concerns remain that a deepening recession could threaten the solvency of some banks and amplify the financial crisis. Confidence is in large measure determined by the current and future state of bank balance sheets, so it’s important that investors and counterparties have a clear picture of whether banks have the capital to weather the current downturn.

But the COP report pointed out that the Federal Reserve, which conducted the tests, did not release enough information about how the evaluations were conducted, which left several “unanswered questions.”

The stress tests showed that 10 of the nation’s 19 largest banks needed to raise a combined $75 billion to be able to withstand an even more severe financial crisis. But the COP said the tests did not account for a bigger economic downturn. Specifically, the COP report recommended that:   

• If the monthly unemployment rate continues to increase, the 2009 average may exceed the 8.9 percent assumed under the stress test, and the tests should be repeated if that occurs. 
• Stress testing also should be repeated so long as banks continue to hold large amounts of toxic assets on their books.
• Banks should be required to run internal stress tests and should share the results with regulators.
• Regulators should have the ability to use stress tests in the future when they believe that doing so would help to promote a healthy banking system. 

You can find the full report here. Read Maloney’s statement and Warren’s testimony here.

The COP, which includes Damon Silvers, AFL-CIO associate general counsel, is charged with reporting on the Treasury Department’s effort to stabilize our nation’s financial system and make recommendations to improve it.

The COP has issued monthly reports since January, finding among other things that the Treasury Department has not produced a plan for restoring lending to consumers, questioned the overall plan to rescue the financial industry and raised concerns about the administration’s plans to stem foreclosures. Commenting on COP’s previous reports, Warren told the committee:

What have we learned thus far? In a crisis, transparency, accountability and a coherent plan with clearly delineated goals are necessary to maintain public confidence and the confidence of the capital markets. Sophisticated metrics to measure the success and failure of program initiatives are also critical. Assuring that the TARP reflects these elements underlies all of our oversight efforts.

Print This Article | E-Mail This Article |Comments (0)