The Stress Tests: The Administration's Real Strategy

05/08/2009 09:50 am ET | Updated May 25, 2011

The stress tests give away the administration's real financial strategy. It is, in sum, as little intervention in the banking system as possible. In other words, there is not much to fix, so let's just get it working again. In other 'other' words, let's bumble along.

The stress test was more or less designed to yield a foreordained result. The banks were graded on a curve. So many banks get an A, so many a B and C, and a few get a D. None gets an F.

Thus, the idea was that no bank need be reorganized by the federal government. All banks designated as needing to raise capital will be able to do so on their own -- most likely.

We shouldn't be too cynical. We now at least have some information about what's on those balance sheets. Hard as it is to believe, the TARP program was rolled out with no serious knowledge of the quality of bank portfolios of assets.

The success of the strategy in the short run will entirely rest, not on the stress tests, but on whether the economy is soon to come back, thus limiting high default rates on mortgages, commercial real estate, business loans, credit card debt, and so on.

It is possible that it will. The Federal Reserve has done an awful lot. The Obama stimulus is now making its way through the economy. The housing plan is reducing mortgage payments for some, freeing up money to be spent or at least to avoid default. The two things that make this period different than the 1930s is that, first, back then, they raised interest rates and refused to pump up the economy through government spending. Second, those New Deal programs like Social Security and unemployment insurance are today significant automatic stabilizers, rising or at least staying the same as the economy sinks.

And banks are indeed making profits in the operating part of their business. They are making losses on their old bad investments, mostly in mortgages assets. They may climb out.

But is this the financial system we want? It is being subsidized to live another day -- and encourage same dangerous investing as before. Oh, the bankers won't do as much for a while, but give them a year or two.

We want a system that does not use savers' federally insured money to invest over-aggressively so that individual bankers can make enormous bonuses. We want a system that will limit the recently famed "Minsky moments," the bubbles which many now agree are the inevitable result of loosely regulated financial systems.

The stress tests make it sounds like the banking system is at least okay. It is the grade the administration wanted, thinking it would make Wall Street confident again. It was like Greenspan and Rubin appeasing the bond traders in the 1990s -- only more is at stake. The banking system is not okay, even if we begin to recover now. Imagine if the Depression ended in 1931. The critical reforms to the nation's future did not begin until 1933.