This Thursday the Treasury Department will announce the results of the vaunted bank stress tests. These tests will allegedly tell us which of the major banks (only specific banks) have sufficient capital to withstand further or protracted economic adversity. That makes sense, doesn’t it?
It makes sense until you actually think about it for a second. All national banks insured by the FDIC receive regular examinations by the Comptroller of the Currency and the FDIC. In addition, publicly traded banks, such as these few, have bank analysts and investors looking at them regularly. What, then, can the Treasury Department add to this scrutiny?
In a word, nothing.
By conducting these stress tests Treasury has devised a clever (although a bit embarrassing) way to justify their future actions with regard to the TARP funds forcibly injected into these banks. If they want to nationalize (or more accurately, further nationalize) any of these banks, they can just say, “We have to. They failed the stress test.”
But why does the government want to keep taxpayer money in the banks when the banks would rather pay it back? Government wants the banks to get back to making imprudent loans, just like before the crisis.
Banks have reached the limit of the amount of money that they can prudently lend because of their capital requirements. Current levels of excess reserves create no impediment to lending. Thus, since the availability of money presents no problem, the government has only one way to get banks to make more bad loans. Treasury must give them so much cheap capital that banks find themselves subjected to market pressures to make those loans in order to improve profits.
If you find yourself scratching your head and saying, “It makes no sense for Treasury to encourage more bad loans,” I would agree, and disagree. I agree it makes no economic sense. It will lead us back into the catastrophe from which we wish to exit. It does, however, make political sense.
People vote for politicians that give them money they do not deserve (whether through handouts or unjustified loans). If they succeed in paying off the loans, it proves they voted for the right people. If they fail to pay off their loans, the unscrupulous banks will again take the blame.
For the banks the stress test means: If you fail, you lose; and if you pass, you lose. And so do we.