Bank Tests Yield Early Progress

By Binyamin Appelbaum
Washington Post Staff Writer
Wednesday, May 6, 2009

The Obama administration's plan to "stress-test" 19 large banks is yielding benefits even before the findings are released tomorrow.

The announcement of the tests in February roiled the markets initially. But the 12-week wait for results has since provided a respite, allowing investors to breathe deeply and giving time for a raft of federal rescue programs to start showing results.

The banks, eager to demonstrate that they don't need more federal aid, have spent the time racing to get stronger. The healthiest banks, such as Goldman Sachs and J.P. Morgan Chase, have tried to show that they can walk without government crutches, for example by issuing debt without federal assistance. Weaker banks such as Citigroup have agreed to sell valuable business units and moved with greater urgency to offload troubled assets.

The main purpose of the stress tests remains largely unfulfilled. Federal officials want banks to raise more capital, from the government if necessary, so that they will have the financial strength to increase lending and help lift the economy from recession. The success of that process, which begins tomorrow and could take six months, ultimately will depend in large part on whether investors believe the government's assertion that many banks are healthy and deserving candidates for new investment. Otherwise, investors might not provide the needed capital.

But in persuading investors to wait patiently for the results, the Obama administration has already succeeded in achieving a goal that largely eluded its predecessor.

"The administration gets full credit for designing and communicating that there would be a new mechanism to determine needs across the system. This was a sophisticated way to establish a timetable that was readily understandable to the market," said David Nason, a Treasury aide in the Bush administration who now works for Promontory Financial.

The seeds of the stress test were planted in the fall, after Henry M. Paulson Jr., then Treasury secretary, forced nine of the largest banks to accept investments totaling $125 billion. This first round of money was intended to stabilize the financial system, but Treasury officials recognized that some of those banks would need more money. The idea of conducting a special examination to determine the needs of each bank emerged as a logical approach, participants recalled.

The deteriorating condition of Citigroup, however, forced the government to act before a plan was complete. A second ad hoc rescue soon followed, for Bank of America, further frustrating senior officials such as Sheila C. Bair, chairman of the Federal Deposit Insurance Corp., who pushed for the development of a standardized approach.

The major innovation introduced in February by Treasury Secretary Timothy F. Geithner was the emphasis on measuring all of the major banks against common standards, leveling out differences in the way firms projected losses.

At the time, the Treasury did not plan to disclose the results to the public, adhering to the long-standing practice of banking regulators that such information is kept secret to preserve confidence in banks and keep information from rivals.

But senior officials said it became clear that investors would dismiss the stress tests unless the government provided data to back its assertions about which banks were healthy and which needed additional capital. The government now plans to release about 150 pages of detailed findings tomorrow, an unprecedented portrait of the nation's largest banks.

Many financial analysts regard this transparency as one of the virtues of the stress tests because it allows investors to differentiate among banks, encouraging renewed investment in the strongest firms.

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