Major Banks Pass Fed's Recession Test

The Federal Reserve says most of the nation's largest banks are healthy enough to survive a severe recession. Fifteen of 19 large banks passed the latest round of so-called stress tests. Some financial institutions responded by rewarding shareholders with higher dividends. But were the tests rigorous enough?

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As we're hearing elsewhere on today's program, economists do not agree on where the economy may be heading next. Whatever happens, though, the Federal Reserve contends that most of the nation's major banks are in position to handle it. The Fed announced results of its stress tests of 19 banks yesterday. Banks that did well on the test promptly celebrated by promising higher dividends to shareholders. But some experts thought the celebration was premature. NPR's Annie Baxter reports.

ANNIE BAXTER, BYLINE: Unemployment could surge to 13 percent, higher than it went at the peak of the recession. Stocks could drop by half. And home prices could plummet another 20 percent. Still, the nation's banks would not collapse. That's what the Fed concluded. Under its doomsday scenario, it says the 19 major banks would lose more than $500 billion. But 15 of those institutions would still have enough capital to absorb the shock of the crisis.

JACKIE REEVES: We are in a much stronger capital position than we were a few years ago. And these are in general very positive stress test results.

BAXTER: Jackie Reeves is managing director at Bell Rock Capital. She says the results clear the way for banks to shower their shareholders with goodies. Several banks said they'll buy back stocks, which boosts share prices. They'll also pay higher dividends.

Wells Fargo and US Bank were among those making such promises. But JP Morgan Chase led the charge. Its announcement of share buybacks and dividend increases forced the Fed to reveal the stress test results two days earlier than planned. Reeves says those shareholder rewards cut into capital buffers that protect banks from insolvency. But the Fed said healthy banks could handle that.

REEVES: Even with these dividend hikes and the buyback plans, they still feel comfortable that that's okay.

BAXTER: Four institutions flunked some portion of the tests, including Sun Trust, Ally Financial, which is an NPR underwriter, MetLife, and Citigroup. But Citigroup only barely failed.

On the whole, finance professor Pete Kyle at the University of Maryland wanted more gloom in the Fed's gloomy test scenarios. He notes that the sovereign debt crisis in Europe could still spell more trouble for the banks, and he worries that the Fed is understating the losses banks could incur, especially potential losses from home equity lines of credit.

PETE KYLE: I would not feel as confident about the banks going forward under the stress test scenario that the Fed has put forward.

SIMON JOHNSON: I think the Fed is cooking the tests in such a way as to really hide the fact that our banks have some serious weaknesses going forward.

BAXTER: Simon Johnson, an economist at MIT, does not think the banks are out of the woods. He says it's always possible that interest rates could go up. That would mean a drop in the value of the government debt that banks have on their balance sheets. Johnson says European banks had a big problem with a similar situation last year. But he doesn't think the Fed's stress tests reflects possibilities like that.

JOHNSON: I think it's an extremely lenient test. And I really don't think it's been applied in a stringent and effective manner. I think it's lame.

BAXTER: But Wall Street didn't seem to think the test was lame. It boosted many financial stocks Tuesday in after hours trading.

Annie Baxter, NPR News.

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