The Obama administration plans to create a "stress test" for big banks as part of the new financial-system rescue plan.
That might have contributed today to the vicious sell-off in financial shares, which once again led the stock market lower. Some investors may have had visions of their bank keeling over during the stress test, much like a terribly out-of-shape person collapsing on a treadmill.
An index of 24 major bank stocks dived nearly 14% today, although it held above its lows of last week. Bank of America Corp. slumped 19% to $5.56, Wells Fargo & Co. tumbled 14% to $16.35 and Citigroup plunged 15% to $3.35.
"A key component of the Capital Assistance Program is a forward-looking comprehensive 'stress test' that requires an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected.
"All banking institutions with assets in excess of $100 billion will be required to participate in the coordinated supervisory review and comprehensive stress test."
What happens if a bank fails the stress test? In a briefing for the press after Treasury Secretary Timothy Geithner's speech, officials suggested that the test wouldn't be "pass or fail," but a question of what level of capital was adequate. The Treasury fact sheet said that a bank that has undergone a stress test "will have access to a Treasury-provided capital buffer to help absorb losses and serve as a bridge to receiving increased private capital."
But that raises the specter of greater government ownership of the big banks -- creeping nationalization -- if they are basically forced to take more taxpayer capital to bolster their balance sheets against further loan losses.
"People think 'nationalization,' and that scared them" on Wall Street, said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York.
Just in the last two weeks, banking giants including Bank of America and Wells Fargo have assured shareholders that they had no plans to ask for additional government funds.
Now they might have to add, ". . . assuming we pass the stress test."
-- Tom Petruno
Photo credit: Stephen Osman / Los Angeles Times
TARP, RIP
ABC News' Betsy Stark reports: Today the Obama administration unveils the financial stability plan, leg No. 2 of the three-legged stool the president says he is building to rescue the economy.
Leg No. 1 is the stimulus plan working its way through Congress. Leg No. 3 is a plan to stabilize the housing market, TBA. The goals here are daunting: to "fix" the nation's banks and to unfreeze the nation's credit markets.
As Treasury Secretary Timothy Geithner is expected to say today, and as Obama has said before, the economy cannot function with dysfunctional banks and credit markets.
This is both an overhaul and an expansion of the Bush administration's TARP, which was successful at preventing the wholesale collapse of the financial system but has been criticized for its ad hoc approach, its failure to revive lending to businesses and consumers and for an embarrassing lack of accountability of how the taxpayers' money was spent.
Here are some fuller explanations of the key features:
1. STRESS TEST for Participating Banks: The administration plans to evaluate the financial health of banks the taxpayer is supporting. How much cash do they have? How many toxic assets do they hold? How many performing and nonperforming loans?
2. MORE CITAL INJECTIONS : Money will be available to those banks whose balance sheets need more cushion to continue lending to their customers.
3. EXPANDED ROLE FOR FEDERAL RESERVE SYSTEM: As private investors have disappeared from the credit markets, the Federal Reserve has attempted to flood these markets with liquidity by using its ability to "print money" as the nation's lender of last resort. The Fed will get more seed money from the remaining TARP funds, which it can leverage into a far greater amount. It will then use that money to try to restart the purchase of loans that are backed by assets ranging from cars to credit cards to student loans to commercial real estate. These "asset-backed" loan markets are critical and they are largely frozen.
4. ‘BAD BANK’ : This idea goes back to the original intent of the Bush TARP program -- to use the bailout money to buy toxic assets from banks in order to cleanse their balance sheets and restore public confidence in their health. But the Obama administration hopes to limit the taxpayers' exposure to these risky assets by making the purchase of these assets a partnership with the private sector. The devil will be in the details here. How do you price these assets that no one wants to buy? How do you incentivize the private sector to participate?
5. HELP FOR HOMEOWNERS: Using TARP money to help prevent foreclosures was only a vague requirement in the TARP program. The quid pro quo will now be more explicit: If a bank wants help from the federal government, it has to help homeowners. The new administration will try to come up with some "national" rules for loan modifications and is expected to advocate to allow bankruptcy court judges to alter terms.
6. TRANSPARENCY: We should all be able to view the results of these efforts on a Web site the Treasury Department plans to set up to monitor how banks are using taxpayer funds.
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