The purpose of the government's stress tests of the nation's 19 largest banks is to find out which will need capital. The evaluations are based on several artificial, and, perhaps, unrealistic criteria. One is unemployment reaching 10% and another is a further, sharp drop in real estate values.
The standards used for the testing may be nearly useless. What if unemployment goes to 12% or commercial real estate loans begin to default at record rates? What if credit card defaults hit levels never reached before? (See 25 people to blame for the financial crisis.)
The process lost more credibility when news came out that banks will be able to challenge the results of the tests between when they get them this Friday and when they will be set in stone the following Tuesday. According to The New York Times, "The banks will then have until Tuesday to dispute any of the findings." And, what will the results of any disputes be? Will banks be able to get the government to change conclusions? Or is the action just a courtesy?
The biggest problem with letting banks go over their grades is that, if they can argue with the government in private, they can take those arguments public. Banks told that they must raise capital can debate the judgment and claim that the entire program is flawed. That may cause shareholders and Wall St. analysts to question the value of the entire process and whether it creates an accurate gauge of bank balance sheets and future prospects.
A test is no test when the conclusions are open to alteration based on the subject of the tests objections. By giving banks time to evaluate their scores, the government is opening a Pandora's Box.
Douglas A. McIntyre
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