What’s Behind Geithner’s Stress Test?

I’ll probably follow this up with some more comments tomorrow but for now take a look at the New York Times article on Geithner’s “stress testing” and what might transpire. Keep in mind that the article is speculative but probably pretty close to reality.

Nearly 100 federal banking regulators descended on Citigroup in New York on Wednesday morning. Dozens more fanned out through Bank of America, JPMorgan Chase and other big banks across the nation.

It was just another workday. For years, regulators have embedded themselves inside the nation’s major banks to monitor their financial health.

But now these regulators could become the arbiters of American finance. Treasury Secretary Timothy F. Geithner is empowering them to decide which banks are strong enough to survive on their own — and which must be compelled to accept new bailouts from Washington, along with any strings that might be attached to them.

At the center of this effort, part of the Obama administration’s plan to shore up the nation’s financial industry, is a new stress test for banks that federal officials are devising.

That’s really kind of weird when you think about it. Wouldn’t you have expected these guys to have been crawling all over the banks about four months ago? What gives here? But forget that for a second and consider these observations from the article.

Details are scant. But exams for 18 or so of the biggest banks are set to begin immediately, and the first results could arrive within weeks. They are not expected to be made public for every institution. Regulators were also discussing whether to apply the stress test to small and midsize banks, according to an administration official.

The new test is likely to be more stringent than the standards used to determine which banks would receive money under the first round of the federal rescue. And unlike in the government’s initial investments, the amount of capital that banks receive will be based on the depth of their problems.

Regulators plan to assess the potential losses a bank could face over the next two years, rather than the typical one year, according to government officials close to the situation. They are also expected to look at banks’ exposure to derivatives and other assets normally carried off their balance sheets, and make sure that banks also carry an additional capital cushion. Their assumptions will be guided on a “worst case” basis.

The exams could be used not only to determine which large banks would receive additional aid but also to help weed out small, unhealthy banks, hastening consolidation in the industry.

Analysts said the program hints at a creeping nationalizationof the banking industry. “There is no way you can survive the failure of the stress test without having the government inject large amounts of taxpayer money,” said Jaret Seiberg, a policy analyst at the Stanford Group in Washington. “That means the government will own a majority of the bank.”

Paul J. Miller, a longtime banking analyst with Friedman Billings Ramsey, said the test might provide the government with political cover to take a more heavy-handed approach. “It gives them the mechanism they need to take giant steps with capital infusions,” he said.

“Maybe the thought is that we will put in so much capital that even under these stringent circumstances, this bank will not fail,” added Martin Lowy, a banking lawyer who advised the Federal Deposit Insurance Corporation on troubled banks during the savings and loan crisis of 20 years ago.

“That will take a huge amount of capital if they are going to do it honestly,” he said. “Why that is different from nationalizing, I don’t know.”

Could this be the future? Perhaps Geithner and the Obama administration feel that the only solution is a sort of back door quasi-nationalization of the industry. Far easier to sell that based on an assessment of insolvency backed up by examination reports then to go at it frontally. And if that is the plan then what is the exit strategy or is there one? Is nationalization the goal?

No need to get too paranoid here but it does smell badly.

more: here

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