BUSINESS
06/05/2009 05:12 am ET | Updated May 25, 2011

Stress Test Leaks: What's The Deal?

The results of the government's stress tests of 19 large financial institutions are supposed to be a secret until Thursday. The banks have been given a "harsh gag rule" forbidding them to disclose any details in advance.

Nevertheless, details are leaking like Edward Scissorhands' waterbed. Almost every day brings a new anonymously-sourced revelation about the tests. To wit:

On Tuesday, April 28, the Wall Street Journal reported that Bank of America and Citigroup would need to raise capital, "according to people familiar with the situation."

Bloomberg reported the next day that at least six of the banks will need capital, according to "people briefed on the matter."

On Thursday Reuters had it that the government was leaning toward announcing the test results for individual banks instead of just summary results, according to "a source familiar with administration talks."

"The source, speaking anonymously because talks are ongoing, also said officials will likely release the capital requirements of the 19 firms at their holding company level, not just the needs of their banking units," Reuters reported.

Then, in classic Fishy Friday fashion, it came out in the afternoon that the stress test results wouldn't be released as planned on Monday the 4th, but rather Thursday the 7th. A "government official" told the Associated Press that negotiations between the banks and the administration had pushed the results back. A Treasury spokeswoman referred the Huffington Post to the Fed for comment. The Fed did not respond.

On Sunday, May 3, the Financial Times returned to the original two deficient banks, reporting that Bank of America and Citigroup are "working on plans to raise more than $10bn each in fresh capital, even as they launch last-ditch attempts to convince the US government they do not need to bolster their balance sheets" -- according to "[p]eople close to the situation."

Two days later on May 5, the Wall Street Journal followed up with word that Bank of America and Citigroup aren't the only bad eggs -- 10 of 19 banks will need more capital, "according to several people familiar with the matter."

Economist Paul Krugman wrote on Monday that the leaks seem like trial balloons, "as if the report's contents may also be dictated by what, based on the response to leaks, the informed public is willing to swallow."

"I think Krugman's right on that," said Dean Baker, co-director Center for Economic and Policy Research in Washington, D.C., in an interview with the Huffington Post. "I assumed they were just playing games, testing public reaction...I don't think these were real leaks."

James Galbraith, an economist with the University of Texas, said he's skeptical that the Fed is really capable of calibrating the public's response to the test results. "That's giving them more credit for wizardry than we have any reason to expect they've got," Galbraith told the Huffington Post.

The focus, Galbraith said, should be on whether the stress tests are sufficiently thorough.

"To what extent do these stress tests evaluate the underlying loan quality and to what extent do they take the bank's own story?" Galbraith asked. "If there's been a searching examination of the documentation behind the loans I would like to know what that examination showed."

On Tuesday Sen. Richard Shelby (R-Ala.) said the test results should be kept entirely under wraps.

James Kwak noted that the banks don't need to do any actual leaking to send a message:

Goldman Sachs, for instance, made a show of raising private capital, issuing new debt without a government guarantee, and offering to repay its TARP money. Jamie Dimon of J.P. Morgan Chase also announced that he could repay his company's TARP money. In both cases, this is code for "We're going to pass those stress tests with flying colors," and the goal is to sow doubt about competitors.

The Federal Reserve said on April 24 that most banks "currently have capital levels well in excess of the amounts required to be well capitalized," though large banks should "hold additional capital to provide a buffer against higher losses than generally expected."

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