The federal government released details of its “stress tests” for major banks Wednesday, saying they must be strong enough to weather a worse-than-expected economic scenario including a 22 percent drop in home prices this year and unemployment topping 10 percent next year.
As part of its revamped plan to restore confidence in the financial system and eventually restart lending, the government said major banks judged too weak to cope with losses on toxic securities and other assets would get six months to raise fresh capital from private investors.
If they are unable to raise that capital, the Treasury Department would force them to take more government money. The Treasury would invest by buying preferred shares issued by the bank that could be converted into common stock at a discount.
Either way, the banks would remain strong enough that customers and investors wouldn’t have to worry about their survival, senior administration officials said.
An index of 24 bank stocks, which slumped after Treasury Secretary Timothy Geithner outlined the stress-test and capital-infusion plans two weeks ago, rallied on the release of the details and on the possibility that the tests might be less burdensome than banks and Wall Street had feared.
Banks received $250 billion in the first round of the $700 billion financial-rescue program. Officials said Wednesday that it was too early to speculate how much additional taxpayer funding might be needed for the latest phase. The assessments are to be completed by April.
Regulators will work with the banks’ own risk experts to assess how the institutions would fare both under a “baseline” scenario, an average of projections by mainstream economists, and under the worse-than-expected scenario.
The baseline scenario calls for the gross domestic output – a measure of the economy’s total output – to fall 2 percent this year, while the adverse scenario envisions a 3.3 percent downturn in 2009.
Banks regularly run their own “what if” scenarios, and Bank of America Corp. Chairman Ken Lewis told Bloomberg TV that the plan wouldn’t pose a problem because it employed assumptions similar to those the bank already used.
The assessments are part of what administration officials described as an attempt to look two years into the future to help prepare government to take action to ensure the stability of the nation’s financial system.
In a joint statement, Treasury, the Federal Reserve and three regulatory agencies said the nation’s largest financial companies – defined as the 19 bank holding companies with more than $100 billion in assets – currently each have a net worth high enough for them to be considered well capitalized.
The new capital assistance plan is designed to maintain that status at the 19 institutions, which collectively hold two-thirds of all U.S. bank assets. The goal is “to ensure that major U.S. banking organizations have sufficient capital to perform their critical role in our financial system on an ongoing basis and can support economic recovery, even in more severe economic downturns,” the statement says.