Bank Test Results May Strain Limits Of Bailout Funding
Much Rides on Size of Capital Needs

By David Cho
Washington Post Staff Writer
Thursday, April 16, 2009

As the Obama administration works to complete its stress tests for gauging the health of major banks, it could confront another problem: how to pay for shoring up any weaknesses the tests reveal.

No one yet knows the extent of the banks' needs. But a senior administration official said yesterday this will be clear once tests on the nation's 19 major banks are done and the results are released early next month.

The administration would be hard-pressed to ask Congress for more rescue funds to plug the holes. Anger on Capitol Hill is high, especially after the furor over bonuses paid to employees at American International Group. The troubled insurer had earlier received more than $170 billion in bailout funds.

But if the capital requirements of banks prove large, the government may need billions of dollars in federal aid back from strong financial firms, which have received that money within the past few months. The administration may even have to carve money from other rescue programs being funded from the $700 billion bailout program.

The task of coming up with money underscores the difficulties posed by the next phase of the government's immense effort to stabilize the financial markets.

Some senior officials say they worry that allowing strong banks to return their bailout funds would stigmatize the firms that couldn't, scaring off their investors. Treasury officials overseeing the rescue effort are willing to take that chance, believing that the risk of such bank runs has receded in recent months as the financial system has become more stable, a senior administration official said.

The official noted that while Wall Street executives have expressed worries about what the government will reveal about their internal conditions in the stress test, the markets have reacted positively as the date of the stress test results has approached. For instance, shares of banks both weak and strong have risen in recent weeks.

The official added that some banks will be able to convert federal aid received last year into common stock, providing these firms the most important kind of capital they need. For that reason, some may not require new government investments.

Still, the stress tests could show that the needs of the 19 banks are substantial, requiring administration officials to rely on bailout money being returned or even scale back other federal programs, government sources said on condition of anonymity because the stress tests are still in their early phases.

Over the past few months, administration officials have outlined ambitious plans that leave them with $32 billion unallocated from the $700 billion financial rescue package -- far less than what officials expect to need for a new round of bank aid, the government sources said.

Treasury officials say they may have as much as $110 billion left over because some of the initiatives are not drawing as much as participation as expected. Many firms have grown wary of taking federal aid, which requires them to cede a measure of control to the government and limit executive pay.

In particular, a program to revive consumer lending, initially projected to soak up $100 billion in bailout funds, may only require $55 billion. The first round of direct government investments into banks, an initiative developed by the Bush administration, was projected to cost $250 billion, but may reach only $218 billion, even after including upcoming help anticipated for some ailing insurance companies.

The Treasury Department also has a contingency plan in case a major financial firm collapses or the shortfall at the large banks proves far greater than anyone in the government now expects. In an emergency, the Treasury can move money out of previously announced programs. Currently, only $303 billion out of the $700 billion bailout program has been disbursed, officials said.

Treasury officials say they conservatively project that at least $25 billion will be returned by recipients of government aid after the stress tests' results are unveiled. In recent weeks, several big firms have said they will pay back their money. Among them are Goldman Sachs, which received $10 billion, and J.P. Morgan Chase, which accepted $25 billion.

Some analysts and officials worry that as strong banks return their government aid, other banks will feel pressured to overextend themselves in order to follow suit. Meanwhile, the weakest banks would be left behind and tarnished.

A senior administration official said no firm will be allowed to pay back money without regulators ensuring that the bank is healthy and able to continue making loans to support economic recovery.

Even if companies begin returning taxpayer money, some analysts and officials say the government may not have enough firepower to accomplish all the goals of the bailout effort, which include buying banks' toxic assets, stabilizing the banking system, reviving consumer lending and helping struggling homeowners and small businesses.

Senior administration officials have said it is likely they may need to ask Congress for more money, but they say such a request probably wouldn't come anytime soon.

In addition, a firestorm over $165 million in bonuses paid to a troubled division of AIG has made the task of asking for more money extremely difficult, officials said.

The senior administration official said fears over another firm melting down like AIG -- whose near collapse last fall threatened the entire financial system -- has significantly diminished. The government demonstrated it will prevent any of the nation's most important banks from failing, spending a total of more than $90 billion to prop up Citigroup and Bank of America.

The stress tests will also help assure the markets that no other major bank will face a fate similar to AIG.

The tests aim to identify the precise areas of need within the banks and provide targeted capital to heal those businesses, the senior official said. They also will provide a clear view of the firms' problems, helping to dispel the uncertainty hanging over the financial system.

"The penalty for opacity or lack of clarity is almost always worse than the truth," the official said.

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