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May 8th, 2009

Stress Tests A Good Thing?

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With all the leaked information and over-saturated news coverage, it seems like the infamous bank “stress tests” are old news by now (even though the results were officially released last evening). Yet I came across an article written by Rob Blackwell in American Banker this morning that took an interesting, and perhaps unpopular, approach. The title of Blackwell’s story is “Stress Tests Bought Time; Will Procrastination Pay?”

Showcasing several experts’ opinions on whether the tests will have a positive or negative lasting effect, Blackwell writes that the stress test could be a good thing, because if nothing else, they bought banks time:

“The strategy of procrastination worked,” said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC. “The Obama administration was playing for time, hoping things would get better. … That seems to be what is happening. … Banks have a lot more options than they did 60 days ago.”

The 10 banks that need to raise more capital have until June 8 to reveal their plan of action, and until November 8 to implement them:

“Now you have some time to see whether this approach is going to work, how bad things are going to get and whether you’re going to need to come up with a way to fund [this] or more government capital,” said Andy Lapierre, the managing director of International Strategy and Investment Group Inc.’s policy research team. “Six months from now you have a much clearer picture on what the minimum losses are, at least.”

But not every banking expert regards time as the ultimate healer. While time has been able to bring some of the stress tests’ (possible) advantages to the surface, time has also dragged out and prolonged the same crisis that got us here in the first place.

Cornelius Hurley, a financial law professor, says the longer banks go without making loans, the worse our situation gets. “If what all this is about is just buying time, then we are not helping ourselves.”

While capital reserves are certainly a cornerstone for a safe and healthy banking system, an over concern with capital shifts an institution’s focus away from the customer to themselves.

What about small banks? With so much emphasis being placed on the health of the nation’s 19-largest banks, who’s worrying about the state of the small and mid-size banks? It’s not as if bank closures have fallen off; in fact 32 have already failed this year.

Blackwell’s article touches on both the positive and negative influences time has had, and can have, on the banks. But an overlooked variable which may ultimately determine how soon the banks recover is the stock market. The more the markets improve, the higher the 19 banks’ shares will rise, the less capital they will have to raise.

So where does this leave us? Were the stress tests a good thing? While it’s true the test provided banks with some breathing room, we believe the true test will come down to whether or not banks can raise enough private capital without the White House becoming an ever bigger stockholder in the nation’s big banks.

For more on the stress test, check out these links:

Fed Sees Up to $599 Billion in Bank Losses” (WSJ.com)

How the Stress Tests Stopped the Market Bleeding” (WSJ.com)

Stress Test Q&A” (USA Today)

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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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