Stress Test Results Shed Light On Banking Sector

The federal government has ordered some of the nation's largest banks to raise a total of $75 billion. The Treasury Department revealed the results of its so called "stress tests" to assess the health of the financial system. Bank of America, Wells Fargo, Citigroup and others will be required to raise more capital.

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RENEE MONTAGNE, host:

It's MORNING EDITION from NPR News. Steve Inskeep is in Kentucky today to address graduates at Morehead State University. I'm Renee Montagne.

And America's biggest banks have finally gotten the grades on their stress tests. The Treasury Department ordered those who didn't do well to raise a total of $75 billion. The stress tests were aimed at assessing the health of the financial system. Among those required to raise more capital, Bank of America, Wells Fargo and Citigroup. And if they do that, the country's top financial officials say the banking system should have enough of a cushion to get through the recession.

NPR's Chris Arnold reports.

CHRIS ARNOLD: For the first time, the government has laid out which banks it thinks are in better shape, and which ones are on weaker legs. That's what the stress test is all about. Simon Johnson is a professor at MIT and the former chief economist for the International Monetary Fund.

Professor SIMON JOHNSON (MIT): Well, a stress test for a banking system is very much like a stress test for your heart. You go to the doctor, the doctor says get on the treadmill, we'll make your pulse rate go up a bit and pump some blood around and see how the heart handles that. So you can't quite do that with banks.

ARNOLD: But what you can do is look at scenarios where banks would suffer more losses. You can calculate what would happen to the banks if the recession got worse, and a lot more loans went bad.

So if the recession gets really, really ugly, it's like making the treadmill go really, really fast and slant upwards and see if the banks are going to fall off and clutch their chest or not, right?

Prof. JOHNSON: Exactly right, so the stress test is all about how hard you push the patient.

ARNOLD: More on just how tough this test was in a minute. A few months ago, though, just the very idea of this kind of a test for banks sent investors fleeing from financial stocks. This was back when Treasury Secretary Geithner gave his first big speech on what the new administration was going to do to fix the banking system.

Mr. DAVID KOTAK (Cumberland Advisors): The speech was a bomb. It laid an egg.

ARNOLD: That's David Kotak, the chief investment officer of Cumberland Advisors. He advises large institutions on how to invest their money. He says that back then, the administration said it was going to get the banks on the treadmills, but it didn't offer any details about how rigorous the tests were going to be or what the consequence of failure would be.

Mr. KOTAK: The markets and the investors and observers around the world wondered if the banking system would survive, and if it needed to be nationalized. There was a big unknown. It was like a black hole.

ARNOLD: Kotak says over the past four or five weeks, though, details have been steadily leaking out, and that helped to encourage investors. The government says it took a hard look at 19 banks, and it says some need to raise a total of $75 billion. That's not good, but it's not as bad as some people feared, and Kotak says the stress tests show that the government thinks the banks are likely to make it through the recession.

Mr. KOTAK: I would expect almost all of the banks to survive.

ARNOLD: The government is hopeful that it won't need to authorize even more taxpayer money for bank bailouts. And the banks that need more cash are now scrambling to raise it. Bank of America was ordered to raise $34 billion. It could sell common stock, and sell off some other companies and assets that it owns. Citigroup's CEO, Vikram Pandit…

Mr. VIKRAM PANDIT (CEO, Citigroup): I'm kind of glad the results have been announced and that this process is behind us. Our plans and actions will give Citi the financial strength to endure an adverse economic situation.

ARNOLD: Still, some economists think that the banks may need more additional help than the government is forecasting. Simon Johnson doesn't think the stress tests were tough enough, and other economists agree.

Professor PETE KYLE (University of Maryland): It is a very soft-ball stress test.

ARNOLD: Pete Kyle is a finance professor at the University of Maryland.

Prof. KYLE: The stress test used a bad scenario laid out by the government. That bad scenario seems to be what we're following now. I think it's quite possible, maybe not likely, but quite possible that things could get worse. Banks are going to need more capital, and they're going to come to the government to get it because the public markets are not going to want to give it to them.

ARNOLD: Kyle thinks the government should be pushing harder for the weaker banks to convert the money it's already given to them into common stocks. The takeaway there, he says, is that that would help prop up the banks, and he says taxpayers would get more upside if the banks recover.

Chris Arnold, NPR News.

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Ten U.S. Banks Need $75 Billion In New Capital

The Fed's Report

The government's long-awaited "stress-test" results have found that 10 of the nation's 19 largest banks need a total of about $75 billion in new capital to withstand losses if the recession worsened.

The Federal Reserve's findings, released Thursday, show the financial system, like the overall economy, is healing but not yet healed.

Some of the largest banks are stable, the tests found. But others need billions more in capital — a signal by regulators that the industry is vulnerable but viable. Government officials have said a stronger banking system is needed for an economic rebound.

Officials hope the tests will restore investors' confidence that not all banks are weak, and that even those that are can be strengthened. They have said none of the banks will be allowed to fail.

"I think why the results were encouraging today is that it showed overall capital in the largest banks is strong and can withstand a great deal of loss in the next two years," John Dugan, comptroller of the currency, whose office supervises more than 1,600 federally chartered commercial banks, told NPR. "But at the same time, common equity, one kind of capital, does need to be increased in some banks, and these banks are already taking steps to achieve that result without, we hope, resorting to government capital."

The banks that need more capital will have until June 8 to develop a plan and have it approved by their regulators.

Among the 10 banks that need to raise more capital, the tests said Bank of America Corp. needs by far the most: $33.9 billion. Wells Fargo & Co. requires $13.7 billion, GMAC LLC $11.5 billion and Citigroup Inc. $5.5 billion.

Some of the firms that need more capital already are announcing their strategies. Morgan Stanley, which the government says needs $1.8 billion in new capital, said it plans to raise $5 billion. That will include $2 billion in common stock.

The tests found that if the recession were to worsen, losses at the 19 stress-tested firms during 2009 and 2010 could total $600 billion.

"Looking at the big picture, you can say that things aren't so bad for the financial industry as a whole," said Kevin Logan, chief U.S. economist at Dresdner Kleinwort.

But Logan said attracting fresh capital will be a challenge for banks that need it.

"The banking industry is not going to make a lot of money going forward, and that's a dilemma for keeping banks solvent and getting them lending," he said.

But Dugan told NPR that he thinks banks have been lending.

"It's been overstated the extent to which people have suggested that they haven't been lending. That's not true," he said. "The data do not bear that out. On the other hand, I believe that increased confidence in the banking system helps the banks, and increased capital buffer gives them more capacity to take the kinds of prudent risks we want to see them take."

Financial stocks surged in after-hours trading, after the report was released at 5 p.m. Citigroup shares jumped 8.4 percent to $4.13, while State Street rose 7.3 percent to $40.60. Earlier, the markets had been down.

The government's unprecedented decision to publicly release bank exams has led some critics to question whether the findings are credible. Some said regulators seemed so intent on sustaining public confidence in the banks that the results would have to find the banks basically healthy, even if some need to raise more capital.

Jaidev Iyer, a former risk management chief at Citigroup, said regulators are playing to public expectations, which could put the government in the role of creating "winners and losers."

Because the government has said it won't let any firm fold, that could put taxpayers on the hook more than a confidential test would have, he said.

"If there is, in fact, no appetite to let losers fail, then the real losers are the market at large, the government and the taxpayers," Iyer said.

In the tests, the Fed put banks through two scenarios for what might happen to the economy.

One reflected forecasters' current expectations about the recession. It assumed unemployment will reach 8.8 percent in 2010 and house prices would decline by 14 percent this year.

The second scenario imagined a worse-than-expected downturn: Unemployment would hit 10.3 percent and house prices would drop 22 percent.

The steeper downturn would make it harder for consumers and businesses to repay loans, which would cause banks' assets to lose value. The government is forcing the banks to keep their capital reserves up so they can keep lending even if the economic picture darkens.

But some analysts questioned whether the tests were rigorous enough. Economic assumptions have changed since the test was designed in February. The U.S. jobless rate has risen to 8.5 percent and is projected to go higher this year.

"The assumptions the government has used are likely not to be completely accurate," said Jason O'Donnell, a bank analyst with Boenning & Scattergood Inc.

From NPR and wire reports.

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