Treasury Stress Test Won't Add Clarity or Transparency - Just Inconsistency

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Includes: BAC, C, GS, JPM, KBE, WFC, XLF
by: Gary Townsend

The Federal government continues to prove itself a poor partner, as inconstant as the moon.

First, the Congress famously changed the TARP rules and replaced business decision-making with parochial politics. Now, the Treasury announces that it will break with long-standing practice and disclose examination results of its stress-testing of the 19 largest U.S. commercial banks. This is not only a particularly poor precedent, but unless all the banks score above average, it holds the promise of damaging investor confidence and destabilizing financial markets.

And don’t believe arguments that this decision will bring clarity and transparency where none exists. Knowledgeable observers know that this whole stress test exercise is a fig leaf for our Treasury secretary, who had nothing else to wear for his notorious coming-out speech last February 10th. In fact, the banks stress test their loan portfolios continuously, most testing credits for their probability of default and loss in event of default loan by loan. Further, they stress their entire balance sheets for asset and liability mismatches, collateral sufficiency on swaps, and the efficacy of financial hedges. And it doesn’t take three months to produce. These processes are well-developed, tested, analytically sophisticated, and subject to continuous onsite review by federal and state bank examiners.

Still, stress-testing is an analytical technique, and a limited one at that. The differences between companies make comparisons difficult. For clarity and transparency, the financial statements and disclosures provide a much more robust set of analytical and comparative data.

Until now, examination results have always been protected from disclosure, due to vital public policy concerns, e.g., to avoid destabilizing financial panics. Isn’t one such panic this decade enough? Unfortunately, this decision is pure politics (of which the supply is apparently endless, the demand side less so), perhaps to provide cover to explain why Geithner gave his stress test such a public emphasis, when it is routine.

The secretary’s decision is wrong headed, improper, and poor public policy. He should be protecting the regulatory examination process from political intrusion. Instead, he invites it.

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