Release of the "Stress Test": Will it Relieve the Stress?
We've now had a few weeks to review and react to the release by the Board of Governors of the Federal Reserve Systems stress test. See The Supervisory Capital Assessment Program: Overview of Results, dated May 7, 2009.
The Fed goes out of its way to state what the stress test IS, and what it is NOT. Specifically, it is NOT a prediction about the future downward movement in the economy, but simply a measurement device that the Fed will use to determine how much of a buffer certain selected large US bank-holding companies (BHCs) would need under a significantly negative set of economic assumptions about the future. The idea is to ensure that even under a relatively dark set of assumptions, major American banks will have the capital to survive.
To that end, a detailed paper on the Supervisory Capital Assessment Program ("SCAP") was released on April 24. The "SCAP buffer" requires that the BHC's attain by the end of 2010, Tier 1 capital of at least 6% of assets and Tier 1 common capital at least equal to 4% of total assets. Of the 19 BHC's in the study, 9 of them already have capital sufficient to meet this requirement. Of the remaining 11 that must add Tier 1 capital, the vast majority of the 185 billion will be added to Tier 1 common capital to attain the 4% requirement.
The Fed makes a point of noting that these hurdles are not designed to be an ongoing regulatory requirement imposed by either the Federal Reserve System or the FDIC. The most important point is that the Fed is acting decisively and quickly in an effort to have major banking institutions design, within the next 30 days, programs to reach the results called for in the stress test mentioned above by December 31, 2010.
Interestingly, the Treasury has not only put in place requirements for shedding certain assets (home mortgages, second tier commercial mortgages and both commercial and residential mortgage back securities (RMBS and CMBS)). Further, the Treasury through offering to the TARP program (principally TALF loans and the Legacy Loan Program and Legacy Securities Program) is not only setting out the requirements but is also providing the tools, for accomplishing the tasks placed before BHCs over the next 2 years.
In effect, we have a road map for the way out. The FDIC, the Fed and the Treasury have acted decisively and in close coordination in an effort to get capital flowing at what may turn out to be surprisingly increased levels toward the end of this year.
Will it work? Stay tuned.
