Jobless put new slant on stress tests/Wall St fears grow over stress test results

Jobless put new slant on stress tests
By Krishna Guha in Washington
Copyright The Financial Times Limited 2009
Published: April 17 2009 22:00 | Last updated: April 17 2009 23:01
http://www.ft.com/cms/s/0/ca1f86da-2b77-11de-b806-00144feabdc0.html


Rising unemployment is prompting US authorities to consider taking a tougher stance in judging the results of bank stress tests, a development that ultimately could force leading financial groups to hold more capital.

The stress test process is intended to ensure that the big US banks have enough equity capital to comfortably survive a recession that is worse than officials presently expect – a so-called “adverse scenario”.

When the stress tests were revealed two months ago, the authorities defined the adverse scenario as one in which unemployment rose gradually to peak at 10.4 per cent in late 2010.

But, since the announcement was made, unemployment has risen much more quickly than was expected, even under the “adverse scenario”. The Federal Reserve and a number of other economic forecasters also revised down their estimates for growth over the next two years.

The upshot is that the likelihood of unemployment reaching 10.4 per cent looks higher than it did at the onset of the exercise.

The authorities believe it is too late to revisit the assumptions underpinning the stress tests. However, it is not too late for them to decide to interpret the implications for capital more stringently. The Treasury declined to comment.

Making such an adjustment would help arguments against claims by critics such as Nouriel Roubini, chairman of RGE Monitor, who wrote on his blog: “The stress test results are meaningless as actual data are already running worse than the worst case scenario.”

The authorities have not yet made a final decision on changing the way the tests will be interpreted. Even if officials do lean in this direction, it may never be visible because they did not specify in advance any precise formula relating stress test outcomes to required bank capital. Moreover, signs of economic recovery could persuade policymakers to disregard the rapid recent rise in unemployment on the grounds that it might revert to the less alarming trajectory they originally expected.

Policymakers also believe that other assumptions in the test still reflect a worse-than-expected outcome. Nonetheless, unemployment is an important driver of loan defaults.

At the same time, administration officials are pressing wary banks and regulators to agree to disclose summary details of the stress test assessment of each bank’s assets. They believe that this information would help markets evaluate the financial health of each bank as well as reinforce the credibility of the stress test exercise. They do not think that even weaker banks could benefit from hiding the results from the market since investors would probably fear the worst.

However, they want to avoid a disorderly situation in which the stronger banks advertise the results of their stress tests while weaker banks resist doing so. This could further stigmatise the weaker banks and lead to an additional loss of confidence.








Wall St fears grow over stress test results
By Francesco Guerrera and Edward Luce
Copyright The Financial Times Limited 2009
Published: April 17 2009 22:00 | Last updated: April 17 2009 22:00
http://www.ft.com/cms/s/0/d780c91a-2b77-11de-b806-00144feabdc0.html


With less than three weeks to go before Washington releases the results of its “stress tests” of the nation’s 19 largest banks, most of Wall Street appears to be in need of Prozac.

Rising panic over how the results will be released has raised fears the results could lead to another collapse of confidence in the battered financial sector. Among other concerns, there is uncertainty over how the federal government will release the results, whether it will publish one aggregate number, or a bank-by-bank breakdown.

In addition, there are concerns as to whether Washington will have the capital to plug any hole it reveals. Wall Street executives believe that some banks will almost certainly require a capital injection, even though Washington is thought unlikely to brand any bank as “failed”.

Although the rules would give banks six months to raise capital from the market before turning to Washington, few believe troubled institutions will have that much time. As one banker said this week: “Once it is known that an institution needs money following the stress tests, they will have about six minutes, rather than six months, to raise the money.”

Banking stocks have performed well in recent weeks as good first-quarter results and some positive signs on the economic front allayed investors’ worst fears over the future of the industry.

However, executives fear that the release of the stress test results, scheduled for early May, could make it apparent the US banking system is split between a small group of relatively healthy companies, such as Goldman Sachs and JPMorgan Chase, and a large cohort of weaker ones.

In addition, if the stress tests force the government to inject capital into ailing institutions such as Citigroup and Bank of America, the move could spook investors and reawaken worries over the nationalisation of some of the nation’s largest banks.

“The government is torn,” said a senior banker. “They have an unpalatable choice between declaring that the banking system is uniformly healthy, which would cause laughter in the market, and saying that some banks need further capital injections, which at this stage can only come from Uncle Sam.”

Bankers who have been involved in the stress tests say the authorities are leaning towards publishing fairly detailed results in early May, possibly as early as May 4. In addition, the Fed plans to release a “white paper” next week setting out the methodology behind the tests.

However, bankers say that over the next fortnight the Federal Reserve, which is carrying out the tests, is likely to tell the banks of its conclusions and give them time to respond – a process that could lead to further adjustments to the actions to be taken as a result of the tests. It could also intensify lobbying by the banks for differential treatment.

The picture is complicated by pressure that stronger institutions, such as Goldman Sachs and JPMorgan, are applying to the Treasury to permit them to repay the troubled asset relief funds they received from the government – not least to escape the conditions Congress has attached to them.

The Treasury appears to be split about the best way forward with some arguing for early repayment, which would showcase the success of the programme, and others arguing it would risk an embarrassment down the line if the economy deteriorated and the banks had to return for further assistance.

In addition, by repaying early, the banks would have escaped the strings imposed by Congress on Tarp recipients, while still benefiting from other government assistance, including debt guarantees. “These are legitimate concerns,” said Douglas Elliott of the Brookings Institution. “One way round them would be to get Goldman Sachs and JPMorgan to agree to continue to adhere to the conditions that apply to Tarp recipients.”