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Deciphering the Results of Banking ‘Stress Tests’

NewsHour economics correspondent Paul Solman explains how stress tests played into the government's decision to let ten big banks pay the Treasury back for the money they received from the federal rescue.

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    That follows more on our top story of the day, the big banks paying back the government. Key to that were what became known as the stress tests for banks. The NewsHour's economics correspondent, Paul Solman, explains what they were all about as part of his series on making sense of the financial news.

  • PAUL SOLMAN, NewsHour Economics Correspondent:

    Well, the stress tests are behind us, measuring how our biggest banks will fare if the economy continues to worsen all year and barely recovers in 2010. The good news was: They all passed. The bad: 10 out of 19 needed more capital.

    But some folks are skeptical of even these results; others have no idea what more capital actually means. So we've concocted our own questions, like the ones you send in to the "Business Desk," for a video Q&A to clarify an issue that promises to be with us for quite a while.

  • First question:

    What is a stress test?

  • Answer:

    an analysis of a bank's balance sheet. And, luckily, we have a balance sheet right here, balancing assets and liabilities. Let me get out of the way so we can fill it in.

    Assets are what the bank lays claim to: cash, fixed assets, like buildings, ATMs, rugs, plus the bank's investments, mainly its loans to businesses and mortgages to consumers. Assets are "good," as the word implies, but liabilities aren't "bad." They're just the sources of the bank's money, loans to the bank, mainly your and my deposits, investments in the bank by shareholders, retained earnings, profits the banks actually earns and holds on to.

    Those last two, investments and retained earnings, are the bank's capital, the difference between what it owns — its assets — and what it owes.

    And, in fact, since the stress tests results were announced in May, the banks have been aggressively raising capital by selling more stock to investors, $85 billion thus far.