…by Meg White
The place Meg puts the stuff she wrote
As Unemployment Soars Beyond Expectations, Congress’ TARP Watchdog Calls for More Stress Tests
Categories: Economy, National, News

by Meg White

Remember how great it was when the results of the stress tests were announced early last month? After shuffling 19 of the nation’s largest bank holding companies through an imagined scenario of stagnant growth, falling real estate prices, and an average unemployment rate of 8.9 percent, 10 banks were deemed to need an additional $75 billion in capital.

Still, 10 of 19 ain’t bad, apparently. Bank stocks rallied and even those who doubted the rigor of the “adverse situation” cooked up by the Fed under which to test the banks concluded the the test results were overall “good news.” The consensus was that we wouldn’t have to come up with any more bailout money.

So now that the panel created by Congress to oversee the Troubled Asset Relief Program (TARP) reports today that they think we should have a do-over of the stress tests, does that mean we get another market rally? OK, probably not. But the fact that banks are using dubious stress test results to try and prove they are strong enough to leave TARP may mean that the administration should take a second look.

The Congressional Oversight Panel (COP), led by Harvard law professor Elizabeth Warren and charged with overseeing the TARP, issued a report presented to Congress Tuesday suggesting the stress tests be re-done and repeated until banks get rid of all their toxic assets.

With May unemployment numbers at 9.4 percent, the stress tests are starting to look more like stress surveys. The COP report noted that while the stress tests weren’t immediately invalidated by the unemployment jump because the tests were constructed under an assumed average unemployment rate of 0.4 percent more that what the current average is (8.5 percent), the report estimated that unemployment “will likely exceed the 2009 average of 8.9 percent assumed under the more adverse scenario.”

At the same time, the Treasury Department announced Tuesday that 10 banks will be allowed to begin paying back $68 million in taxpayer money received via TARP, a decision based partly on faulty stress test results.

Warren argued at a hearing convened to present the panel’s report to the Joint Economic Committee of Congress Tuesday that accurate, truthful information is key to decisions to be made about how to fix the economy.

“Without it, we cannot rebuild our financial system. We cannot rebuild it on clouds. We have to rebuild it on reality,” she said.

To her credit, Warren has been begging for more information about TARP since she began as chair of COP. But now that banks are using the results of the stress tests to make arguments about their financial fitness, transparency is more vital than ever.

It’s important to note that the idea of a stress test is not a new one. The COP report notes that stress testing is part of the normal job of a bank examiner tasked with inspecting a bank’s assets to make sure it can weather tough times. Usually, the results of such bank examinations are kept confidential, but in this case they were made public. Part of the reason for this was likely to avoid the perception of improper spending of taxpayer funds. But the COP report notes that “because the stress tests were undertaken in order to restore confidence in the banking system, they included an unprecedented release of information.”

In other words, the stress tests were partially a fact-finding mission, but they were also a public relations scam. Because the public was going to have access to the results, and because part of the very mission of the tests was to restore confidence in banking so that investors would return to pouring their money into bank holding companies, the tests couldn’t be too tough. The Treasury couldn’t let too many failures happen, or confidence would be shaken.

This is the problem with what I call the No Child Left Behind method of bank regulation: Teaching to the test results in under-education. Fixing the conditions under which a bank is to be tested so that they mirror the conditions under which a bank should be able to survive tells us nothing about that bank’s actual stability. Furthermore, it gives banks license to say they are healthy enough so that they can exit TARP, which they see as a burdensome system due to hiring and executive compensation restrictions.

One of the conditions these 10 banks were deemed to have met in order to leave the TARP was solving the deficiencies called out by the stress tests. If the stress tests have lost most of their meaning, should Treasury really allow banks to leave TARP based partially on the results?

This article from CNN Money indicates a degree of discomfort from government officials in allowing banks to begin repaying TARP money, suggesting the banks may not be ready yet but simply rushing to exit the program due to restrictions as well as the stigma attached to being a welfare bank:

Tuesday’s announcement represents a major compromise from government officials. Regulators have been fearful about the nation’s largest banks’ ability to weather the current economic climate as the unemployment rate marches higher and signs of trouble crop up in new areas like commercial real estate.

Regardless, it seems to matter little whether the government thinks these 10 banks are ready to repay or not. The stress tests gave nine of these banks a de facto clean bill of economic health, whether it was true or not. And trouble brewing in the commercial real estate market coupled with the fact that the stress tests only projected to the end of 2010 makes it difficult, if not impossible, to say we won’t be bailing out these 10 banks within the next few years.

But at least those bank CEOs will have big healthy paychecks until then.

It may seem paranoid to assume the money to be repaid by these 10 banks would end up being recycled back to shore up financial institutions once again, but that very concern was expressed at the joint committee hearing today. After all, Treasury Secretary Timothy Geithner has said the money to be repaid will be held in case it is needed to further recapitalize banks. Warren speculated at the hearing today that Treasury would probably use the money in such a way, unless Congress instructed the department not to do so.

Rep. Kevin Brady (R-TX) deemed the money a “revolving slush fund” and called for the dissolution of Warren’s panel, citing the fact that the COP hearings had not included major banks and that Treasury had only testified before the panel once.

Warren objected that Congress had given the panel no subpoena power. The panel’s inquiries were also defended at the hearing by Rep. Elijah Cummings (D-MD) and by Committee Chair Rep. Carolyn Maloney (D-NY), who said that a bill she had introduced (H.R. 1242) to amend the Emergency Economic Stabilization Act of 2008 would require Treasury to make publicly available more information about the TARP, solving some of the panel’s access issues.

The COP report also raised questions about the secrecy under which the stress tests were conducted. As anyone familiar with scientific testing knows, no results are valid if the test cannot be replicated by outside observers. Warren called for the release of the methodology of each specific test so that the panel could retest independently. The report links the lack of transparency directly to the efforts of some banks to pay back TARP loans, perhaps before they are ready:

Transparency will also be critical as financial institutions seek to repay their TARP loans, both to assess the strength of these institutions and to assure that the process by which these loans are repaid is fair.

Finally, the Panel cautions that banks should not be forced into counterproductive “fire sales” of assets that will ultimately require the investment of even more taxpayer money.

Cummings repeatedly expressed concerns over transparency at the hearing and questioned whether or not those 10 banks should be allowed to return taxpayer money.

“Now we are asked to accept the contention of the banks and their regulators that the stability of the global economy is not jeopardized by the withdrawal of the same public funds from private firms that were considered so critical to the survival of our economy just a few months ago. Accordingly, in order to accept these claims we again require transparency regarding the actions of all the players,” he said in his opening statement.

Warren did note that transparency had improved since the change-over in the White House.

“We had a Treasury Department that was not forthcoming with information. That has changed. The Treasury Department has been forthcoming,” she said. “We simply are asking for more.”


Originally published at BuzzFlash.com.

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