There is ‘One More Thing’: Those Stress Tests

To cap off a day of banking fun:

What about those stress tests?

We are about to get the roll out of the results. So here’s what we are watching for:

There are nineteen major banks being reported on. Obviously they run the gamut in terms of health. So the difficulty the administration now faces is how to release the test information without immediately sending the shares of the weaker banks into a tailspin? It’s one thing to announce that bank ‘A’ is fine, it’s quite another to say that bank ‘B’ failed the test. The only rational response an investor could have to bad news like that would be to sell stock quickly. The implication is that the weaker banks will require more capital, and the only source is the government. It is a scenario that could spin out of control very quickly.

Conversely, the administration faces some tough issues with the healthier banks. Will it be OK for the stronger banks to repay their TARP money? If so what does this do for the administration’s attempts to institute an overhaul of bank regulation? And doesn’t allowing some banks off the government hook give them an automatic leg up in the financial system? Think about that: the market would be justified in charging a hefty premium to any bank that had been exposed as weak. So the weaker banks would start having to pay much more than their rivals for funds, which would reinforce their weakness.

So releasing the stress test results, which sounds terrific as an example of transparent government, could have dire unintended consequences that could then, in turn, force the administration into adopting unpopular policies … like nationalization!

For those of you who really want to get a longer dose of the stress test issues I suggest this Financial Times article.

In any case this is something to keep a close eye on over the next few weeks as the results are inevitably leaked and discussed. The ramifications will be fun to watch as they play out.