One of the key components of the Treasury’s Financial Stability Plan is for banks with $100 billion plus in assets to take a “comprehensive stress test.” Since the Financial Stability Plan was short on details, we can’t completely rule out the possibility of putting qualifying bank chief executives on a treadmill. Two banks that will need to get an exemption from taking the stress test are Goldman Sachs (GS) and Morgan Stanley (MS) as they were given a period of time to gather deposits and bring their leverage and risk profiles down to that of a traditional bank. This is just the start of a trail of inconsistencies that will begin to surface as stress testing commences.
Far more interesting is what the underlying motivation for the stress test is given that the Federal Reserve and other regulators are already supposed to be performing this function. As the former president of the Federal Reserve Bank of New York, Treasury Secretary Geithner should have carefully “stress tested” Citigroup (C) and the other original TARP recipients. It appears that the Obama Administration wants to use the nation’s largest financial institutions to carry out its social-financial agenda. Most of these banks (with the exception of Bank of America (BAC) and Citigroup), have publicly stated they no longer want to play ball with the Treasury or be constrained by its new rules. The Treasury gave Fannie Mae (FNM) and Freddie Mac (FRE) the 79.9% solution to carry out its mortgage agenda, but we have yet to see 4.5% mortgage rates.
Stress testing is the method to force “healthy banks” to do their patriotic duty. If banks refuse to increase lending or modify mortgages in a manner satisfactory to the Obama Administration, the Treasury can start a witch hunt that’s bound to find enough stresses to coerce cooperation. The objective is to make the stick so big that the nation’s largest and most influential banks will abide by the Administration’s standards of good behavior. The implicit threat is that no bank would want to be identified as being in a stressful situation, so it’s impossible not to cooperate with the government. The reason that only the largest banks will be publicly stress tested is that they are deemed to be too big to fail and therefore not in danger of a bank run.
Despite the Administration’s rhetoric, neither the criteria nor the results of the stress tests will be publicly revealed because this is a case where truth and transparency are incompatible.