TOPICS > Economy

‘Stress Tests’ Put Credibility of Banks, Regulators Back in Spotlight

May 7, 2009 at 6:20 PM EDT
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On the day the government released better-than-expected stress test results for 19 major banks, a panel of economic analysts explain how the numbers were calculated and gauge the report's impact on the nation's financial health.
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JUDY WOODRUFF: First, the stress tests on the banks. We begin with more from Charlie Rose’s interview with Treasury Secretary Timothy Geithner. He was asked about the purpose of the tests and what the government hopes to achieve.

TIMOTHY GEITHNER, Treasury Secretary: This financial system at the beginning of this year was operating under a deep cloud of uncertainty, great loss of confidence. People were very worried about whether the scale of losses that might come in a deeper recession would be sustainable for this system.

And banks were unable to raise equity, could not borrow without guarantees from the government, and they were being defensive. They were pulling back on lending. And that was sucking oxygen out of recovery, deepening the recession. And that’s — fundamentally underpinning that was a sense of concern, lack of confidence, again, about how strong banks were.

So what we did with the Fed is, for the first time ever, we brought the nation’s financial supervisors together and, in an unprecedented step, asked them to do a careful look under the hood, to take a careful look at how much — how strong these institutions were in the event things got worse.

And what these results will do is they will bring in a level of transparency to bank balance sheets that’ll allow investors to judge, make it easier for them to raise capital, improve confidence that this system is going to be strong enough to get through this, and that will be enormously helpful.

It will be an important next step forward. Again, because of the virtues of bringing disclosure and transparency, it will help lift this fog of uncertainty over the financial system, and I think the results will be on balance reassuring.

CHARLIE ROSE, PBS Host: Two things. One, transparency was necessary so that people would have confidence in the numbers that you release?

TIMOTHY GEITHNER: That’s right. They get to judge. They’ll get to see them. They’ll make their own judgments. But you’re going to hear criticism from both sides on this, Charlie. A lot of people will say these were unfairly tough.

CHARLIE ROSE: And the other side, they were not tough enough?

TIM GEITHNER: And there will be other people who say that, you know, that losses could be worse. And they may be right. But this was designed — again, designed by the Fed — to get the balance right and to strike the right balance.

And it is a very exacting set of standards. Again, because what we want to do is to make sure that people have confidence that our financial system is going to be able to get through this and going to be able to lend. And to be able to lend, they need to be able to raise equity and have a stronger cushion against future loss.

Striking the right balance

Dean Baker
Center for Economic and Policy Research
I'm still concerned that this is not sort of an adequate test. Basically, the test was not tough enough.

JUDY WOODRUFF: And now back to Jeffrey Brown for more.

JEFFREY BROWN: So that's how Secretary Geithner sees these stress tests. We do our own analysis of them now with Robert Glauber of Harvard University. He's a former Treasury official under the first President Bush.

Dean Baker, co-director of the Center for Economic and Policy Research, a Washington think-tank.

And Steve Bartlett, president of the Financial Services Roundtable, a trade group representing investment, securities, insurance and banking companies, including most of the 19 banks that participated in the stress test.

Well, Robert Glauber, we just heard about trying to strike the right balance. What's the most important thing that you learned today? What do you take from this?

ROBERT GLAUBER, Harvard University: Well, I think they did strike the right balance. It's a balance test. It's a workable solution. Clearly, it will generate more confidence in the market. It already has, in after-hours trading.

It has one very important weakness: Its basic premise is to let the banks work their way out of the problem, to earn their way out of the problem over a couple of years. And during that time, the banks aren't going to be as strong as they could be, and therefore it won't be able to make the kind of loans that are really needed to lift the economy as rapidly as one would hope it would.

JEFFREY BROWN: Dean Baker, general proposition, what did you take from this?

DEAN BAKER, Center for Economic and Policy Research: Well, there weren't that many surprises, because much of this had leaked, presumably deliberately, in the last week or so.

But I have to say, I'm still concerned that this is not sort of an adequate test. Basically, the test was not tough enough. The bad scenario assumed an 8.9 percent year-round average unemployment rate for this year and 10.3 percent for this year. It's likely the unemployment rate released tomorrow is going to be 9 percent. We're going to see a much higher unemployment rate.

They assumed that house prices would fall in the bad scenario 22 percent, that index house prices have been falling at a 24 percent annual rate over the last half-year.

So to my mind, it was to some extent a cooked test. I mean, not to say they were illegitimate numbers, but I would have liked to have seen a somewhat harsher test to determine how solvent the banks actually are.

JEFFREY BROWN: You mean too rosy a scenario to compare the banks to?

DEAN BAKER: Exactly. I mean, basically what you'd want in a stress test is a bad scenario and sort of the worst plausible scenario. And in some ways, I think this is an optimistic scenario.

JEFFREY BROWN: Steve Bartlett, credible test, credible stress test?

STEVE BARTLETT, Financial Services Roundtable: Well, it didn't seem like an optimistic scenario to us, those of us receiving it. It was a pretty tough test. It was a tough test that, assuming a worst-case scenario, looking forward, how bad could it get?

And what we discover is not only are these financial institutions pretty much well capitalized today, but under a worst-case scenario will be well capitalized going into the future.

It does create some opportunities or some needs to raise additional capital and lays out a platform for doing that. All of that is achievable. So it's good news for the economy, good news for the financial sector, but I think good news for going forward and getting the recovery started.

'Pushback' from banks?

Robert Glauber
Harvard University
This was on the tough side of where most people are. It could have been, as Dean Baker says, tougher, but I don't think it was unfair.

JEFFREY BROWN: You were listening when I was interviewing Deborah Solomon, and she was talking about how many of the banks were pushing back during this week. Does that sound right to you?

STEVE BARTLETT: Actually, no, it doesn't. I think that the Treasury did do the right thing. It spent about 10 days of sharing the results of the tests and then letting the banks then respond to specific line items. "Well, you didn't quite get it this way. Try this."

But there wasn't any pushback or negotiation. It was a matter of understanding the test. It gave the banks the chance to understand the test and Treasury the chance to understand the bank balance sheets. So it came out taking the extra week-and-a-half was a good thing, because then everyone understands it a lot better.

JEFFREY BROWN: Well, Robert Glauber, one thing this was clearly intended to do -- and we heard it from Secretary Geithner -- was to end the uncertainty, including even about whether some banks were insolvent. Does it do that?

ROBERT GLAUBER: Well, it does end the uncertainty. And the test is a balanced test. You could say it should have been tougher, it should have been less tough, but it's a balanced test. It ends the uncertainty.

It doesn't necessarily create by the strategy strong banks that are going to be able to make the kind of loans that are necessary to build the economy over the next two years, because these banks still are going to have on their balance sheet large numbers of very bad assets and only over time do they get rid of those and replace them with good loans.

JEFFREY BROWN: But just staying on the credibility of the test itself, because Dean Baker raised the rosy scenario idea, where do you come down on that?

ROBERT GLAUBER: It could clearly have been a tougher stress test. It's always a question in these things, how bad is bad? This was pretty bad. This has a 10.3 percentage unemployment rate. Most economists think it will peak out somewhere around 10 percent, 10.1 percent.

So this was on the tough side of where most people are. It could have been, as Dean Baker says, tougher, but I don't think it was unfair.

JEFFREY BROWN: Dean Baker, are you worried that there's a danger -- that we're being too overoptimistic? I mean, we talk about a rosy scenario, but then we get these results. Your suggestion is that we -- we don't really still know how bad the situation is for many banks?

DEAN BAKER: That's right. Again, I would argue, again, that I don't think -- just to be clear, I'm not saying that they cooked the tests, but they came up with those projections at a time when most economists had a more rosy view of the economy.

So when they first designed the test, I don't think those would have been unreasonable, given what most economists were saying at the time. But we've had several very bad months, so -- again, just to take the '09 unemployment rate, 8.9 percent, we're going to see 9 percent tomorrow. I'll be very surprised, and it's going up from there. So I think it's an overly rosy scenario.

And the problem you get into is, at this point, we have everyone saying, OK, this is good, the banks are solvent, everything's fine. What happens, let's say, three months or six months down the road, and it's clear things are worse than that, we can go back to Congress, we can say, "We need more money," but that's going to be a very difficult problem both for the economy and also the politics of it.

I don't think President Obama wants to be there. It's going to be very difficult.

JEFFREY BROWN: So his credibility now is...

DEAN BAKER: His credibility is really on the line with these.

JEFFREY BROWN: Do you see that...

STEVE BARTLETT: Well, one of the good news about this test is it appears that there's no need to go back to Congress for additional TARP money, that it all can be funded with the TARP money that's already been issued.

JEFFREY BROWN: Well, that's a question. I mean, that's a question. Is that the way you see it?

STEVE BARTLETT: No, that's the way I see it. It almost is virtually certain at this point, because the equity will be, first, from private equity. They'll raise private equity. And only if they can't do that, then they convert existing TARP preferred into common. So there's very little additional TARP money that will be needed.

So I think this takes off the table, in my view, the idea of going back to Congress for more TARP money. And I think that's good. I think kind of that was then and this is now, and it's time to move forward without additional TARP funds.

Toxic assets still a problem

Steve Bartlett
Financial Services Roundtable
I think, weak or strong, I think banks will have to sell assets. This is a time to sell assets, get the cash, get the capital, and then use that capital for additional lending.

JEFFREY BROWN: What about what I asked Deborah Solomon about the possibility that some weak banks will have to sell assets?

STEVE BARTLETT: Oh, I think some will. I think, weak or strong, I think banks will have to sell assets. This is a time to sell assets, get the cash, get the capital, and then use that capital for additional lending.

So non-core assets -- I think banks were already selling non-core assets, both subsidiaries and real estate. And that's the way it should be; that's good, prudent management.

JEFFREY BROWN: Robert Glauber, why is it useful -- I mean, we're all waiting for this moment to kind of see which banks are strong and which are weak. Why is that now useful, now that we're there, to the degree that we are there? We don't have total agreement on that. But to the degree we are, why is it useful? What does it let us do now?

ROBERT GLAUBER: Well, first of all, it removes uncertainty. And as everybody has said, markets don't like uncertainty. At least now, as Secretary Geithner said, people can look at the data and can make their own measures. And that's always good for a market.

It also tells certain banks they have to get on with the job of raising capital. Some people might argue they have to raise more capital than the government said, but it does tell them, "It's time to get going. You can't hold back any longer. You've got to do it." And it gives them a path.

They can raise most of the capital, as Deborah Solomon said, by just changing the form of the capital they have from the government into a different form. It does mean that the government would have some ownership of the banks, and they probably -- I'm sure they don't like that.

But it does allow them to get on with the task, and everybody's been holding their breath until now. This is a good thing to remove the uncertainty.

JEFFREY BROWN: What about the question that, you know, we've talked about a lot here, the question of the so-called toxic assets? Does this help settle that question? Do we know more about the depth of that problem?

ROBERT GLAUBER: Well, we probably know more, but it certainly doesn't settle the problem. What this does is still leave those assets on the balance sheets of the banks. And as long as those assets are there, the banks can't fill their balance sheets up with loans to companies that can hire people, build things, lift the economy.

And that probably is the major defect of this. It leaves those toxic assets in place on the balance sheets of the banks and doesn't give them any real stimulus to move them out. And that, I think, is really where people will debate this and ask, should there have been a plan that dealt with those toxic assets?

JEFFREY BROWN: And, Dean Baker, you would say, "Yes"?

DEAN BAKER: Well, I mean, I think there's a real problem with the toxic assets. I mean, they're holding them on their books at prices that are well above their market value, and we do have the Geithner plan that, to my mind, is a serious subsidy.

It's basically this story where you have investors come in taking risk with the government money, which is certainly going to increase the price that the banks will get for those assets, and I'd be sort of inclined to say, well, if the banks are in such good shape, why do we have to have this separate program subsidizing them to buy these assets?

So I'm very troubled by, you know, how much money we're giving to the banks through the Public-Private Investment Plan and other routes. And, you know, if the banks are in great shape, why do we have to give them more money?

JEFFREY BROWN: Well, what's the answer?

STEVE BARTLETT: Most of the banks don't want to sell those particular assets, sell them at least at current market prices, because it was a $100 asset. It's on their books for $80 today, and the sale price to PPIP, as it's called, is $40. The bank would just as soon hold onto it and then resell it at $40 when it goes up.

So someone's going to own those assets. And a bank is saying, "If I have to write it down today back to $40 bucks, then I'm much better holding on and making the profit for the bank rather than turning it over to somebody else."

I think that program has not yet started. It's trying. I think there's a balance there somewhere. I don't think it's related to today's news. I think today's news is about capital going forward. But I think it does have to get solved.

More tests possible

Robert Glauber
Harvard University
This isn't the end of [the stress tests]. But this is certainly the high-profile banks. And, again, what it does, it will remove an immense amount of uncertainty and lets the industry get on with the task.

JEFFREY BROWN: Let me ask you about -- there's so many other banks out there. We heard about a few today, and those aren't going to go through a stress test, it sounds like.

STEVE BARTLETT: Actually, they will...

JEFFREY BROWN: They will?

STEVE BARTLETT: ... in my view. I think, in fact, all 19 of these banks had been undergoing their own stress test for some time.

This is the first time that a stress test had been conducted by the government and then made public. And that's what caused a lot of the stress and anxiety, is the transparent nature of it. We're all for it. It was the right thing to do, but it still creates some anxiety.

I think that the other banks will and already are going through their own stress test using the same scenarios and then working with regulators to determine where they are in the process. So I think the process will then migrate to the other banks, and it should.

JEFFREY BROWN: But not quite a formal stress test like we've just been through?

STEVE BARTLETT: Time will tell. It won't be quite as high a visibility. Maybe the spotlight won't be quite such a glare. But I think it will be a serious -- and it needs to be. Banks should put their assets and their capital through a stress test, find out where they are before the problems develop.

JEFFREY BROWN: Do you expect to see that, Mr. Glauber? Or do we need to see that for all these other banks?

ROBERT GLAUBER: Oh, sure. There are a lot of other banks that have to go through it. I believe the regulators will put them through some version of this, and some will be, again, revealed to need more capital.

That, as Steve Bartlett has said, is a process that will go forward. This isn't the end of it. But this is certainly the high-profile banks. And, again, what it does, it will remove an immense amount of uncertainty and lets the industry get on with the task.

JEFFREY BROWN: All right. We'll leave it there. Robert Glauber, Dean Baker, and Steve Bartlett, thank you all three very much.