Will Bank Stress Tests Soothe Public Fears?

These days, many Americans may feel they are facing one stress test after another.

Bankers can relate. In recent weeks, federal regulators have been conducting so-called stress tests at 19 of the nation's largest financial institutions. The tests were designed to determine just how well — or not — the most important U.S. banks are holding up under the strain of bad loans.

The regulators already have revealed the test results to the banks. In the coming week, they are expected to tell the public what the stress tests uncovered.

Such tests are different from the usual accounting examinations. Normally, accountants add up revenues and subtract expenses to figure out whether a company is making a profit. But a stress test is a simulation experiment: The regulators run calculations, based on bad but plausible scenarios, to estimate whether a bank has enough capital to withstand hard times.

Economists say it's similar to when a couple sits down with a budget and asks each other: What would happen if you lost your job for three months? What if we both lose our jobs? Could we make it to next month? The financial exercise is intended to help understand how much financial stress you can take before you need outside help.

These bank stress tests could be important because they could shore up public confidence in the financial system. In large part, the economy is hurting because investors lack confidence and the banks themselves are unsure about lending more money. Economists say that to end this recession, financial institutions will have to persuade customers that they are well capitalized.

Most industry observers are predicting the tests will confirm that some well-known companies, such as Citigroup and Bank of America, will need more capital, either from private investors or taxpayers.

But a number of analysts and financial bloggers are skeptical about whether the tests will reveal the full extent of the banking industry's problems. They fear banks are still using accounting dodges to keep from revealing just how many bad loans they have made. They worry, too, that federal officials are too eager to reassure Americans that the worst of the credit crisis is over. In April, Treasury Secretary Timothy Geithner told Congress that the "vast majority" of U.S. banks have more capital than needed.

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