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February 26th, 2009

Stress Tests Begin — Gov Moves In

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The Office of the Comptroller of the Currency (OCC) announced yesterday that federal bank regulatory agencies will begin their financial assessment of certain financial institutions to “estimate the range of possible future losses and the resources to absorb such losses over a two-year period.” Under the Capital Assistance Program (CAP), large banks, which collectively hold “roughly two-thirds of aggregate U.S. Bank Holding Company assets,” will be assessed under a baseline scenario of potential future economic developments, and also under a more severe set of potential circumstances referred to as an adverse scenario.

Regulators will weigh the institutions’ liabilities and assets against their capitalization. If regulators discover a deficit, the Treasury will provide whatever funds necessary to fulfill their capital requirement.

The Treasury will provide the institutions with capital in exchange for convertible preferred securities, which can be changed into shares of the banks’ common stock. Banks will have six months to replace government money with private funds. The institutions will be responsible for raising private capital in the marketplace in order to cover the government’s “loan” of capital — if they can or want to.

In the instance where the capitalization and conversion results in a greater than 50% share for the government, the institution would be considered “nationalized,” at least temporarily, since the government would control a majority of the company.

While this program is designed to only be temporary, there’s a serious chance that the government won’t quickly relinquish control of an institution it “owns.”

“Once the government gets its claws into an industry, it’s often hard to get them out,” said HSH Vice President Keith Gumbinger.

What will happen if banks can’t raise enough private capital and the U.S. Government ends up becoming a majority shareholder? How quickly will the government return the firm to private ownership, and at what cost to the owners?

Click here for the OCC’s list of FAQs regarding the Capital Assistance Program.

(Keith Gumbinger contributed to this article)

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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