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Fed says gov't ready to save stress-tested banks

DANIEL WAGNER   04/24/09 10:43 PM ET   AP

Stress Tests

WASHINGTON — The government signaled Friday that some distressed banks will need to raise more cash to meet stricter standards it has set for the 19 financial firms that took its "stress tests" and suggested it's ready to step in with more federal help.

Federal Reserve officials held top-secret meetings with bank executives to give them preliminary findings of how each bank would fare if the recession got much worse. It reinforced the Fed's view that major financial firms are "too big to fail," and that the government must do whatever is necessary to save them.

"It appears 'too big to fail' is a fundamental philosophy," said Mark Williams, a finance professor at Boston University and former Fed examiner.

Fed officials told reporters that all 19 banks will be required to keep an extra buffer of capital reserves beyond what is required now in case losses continue to mount. That means some banks will likely have to raise additional cash.

But the Fed stressed in a statement that a bank's need for more capital reserves to meet the requirements should not be considered a measure of the "current solvency or viability of the firm."

Senior Fed officials also told reporters that regulators will keep a close eye on banks to make sure they have adequate capital to withstand further losses on mortgages and other bad assets as the recession drags on.

The tests of the 19 financial firms, which hold half the loans in the American banking system, are a centerpiece of the Obama administration's financial rescue plan. They were intended to boost confidence in the banking system by giving investors signals about the relative strength of the nation's largest financial firms.

The Fed is also using the results to determine which firms need to raise more money or take other action to strengthen their positions.

The government plans to announce the results of the tests May 4. By law, the banks cannot publicize the results without the government's permission, and the Fed itself offered little new information Friday. But Wall Street buzzed with anticipation, and most financial stocks rose. The Dow Jones industrial average added more than 119 points to close at 8,076.

In New York, Gary Cohn, the president of Goldman Sachs, met with Fed officials inside the iron-barred Federal Reserve Bank of New York, a neo-Florentine fortress that sits atop the world's largest gold repository.

Hours later, John Mack, the CEO of Morgan Stanley, arrived in a silver sedan with dark-tinted windows, showed his identification to security and entered the building. He left about 45 minutes later.

Critics remained concerned that the tests have had the opposite effect of what the government intended _ creating uncertainty that feeds market instability.

"I really don't think this is going to add transparency to the system," said Linda Allen, a finance professor at Baruch College. She said the tests are similar to bank examinations that are done regularly to ensure banks have enough money to absorb further losses.

In the tests, the Fed put banks through two hypothetical scenarios for what might happen to the economy.

One scenario reflects forecasters' current expectations about the recession. It assumes unemployment will reach 8.8 percent in 2010 and house prices will decline by 14 percent this year. The second imagines a worse-than-expected downturn: Unemployment would hit 10.3 percent and house prices would drop 22 percent.

Recent economic indicators suggest the economy is approaching the more severe of the two, said Paul Miller, an analyst with Friedman, Billings, Ramsey & Co.

"The question is, will the market accept the stress test as a realistic case?" he said.

Regulators also used the tests to examine the quality of banks' loans and other assets, according to Fed officials.

The tests could be especially hard on regional banks because some of them hold massive portfolios of mortgage and other loans in areas that have been hit hard by the foreclosure crisis. By contrast, Wall Street brokerages like Goldman Sachs and Morgan Stanley hold more of their assets in securities, which regulators feel have already been priced down in the market.

The Fed has several tools for shoring up bank finances. One is converting the Treasury Department's loans to the banks into shares of common stock. Another is forcing the banks to raise money in private markets or receive more money from Treasury's bailout fund.

In extreme cases, a rescue could include a government-backed merger, similar to what regulators did in helping Bank of America to buy Merrill Lynch and JPMorgan Chase & Co. to buy Bear Stearns.

Battling the worst financial crisis since the 1930s, the government has committed more than $11 trillion in loans, investments and other measures to prop up troubled institutions and stabilize the banking system.

For months, officials have put off questions about the banking system by saying they're awaiting the results of the tests. The delays have led investors to fret: If the tests show every bank to be strong, they will look like a whitewash and won't be taken seriously. Yet once investors can distinguish stronger from weaker banks, they could start fleeing from weaker banks.

News reports, including a confidential outline of the tests first reported by The Associated Press this week, led analysts to start handicapping which banks could fail. Friday's announcement put some of those fears to rest, underscoring that the Fed will not say any bank lacks the reserves it needs to survive.

The banks will have a few days to review the results and appeal any findings. Regulators will give them final results May 1, according to two people familiar with the matter who spoke on condition of anonymity because they were not authorized to discuss it publicly.

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Associated Press Writer Jim Kuhnhenn and AP Business Writers Stevenson Jacobs and Tim Paradis in New York contributed to this report.

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Filed by Julie Satow  |