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Stress tests made obsolete

Banks raised needed funds but things changed

By Daniel Wagner and Stephen Manning
Associated Press / November 10, 2009

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WASHINGTON - All but one of the 19 largest banks have raised the extra capital cushion regulators said they would need to withstand a deeper recession - a sign, the Treasury secretary said, of how much the financial system has improved since the crisis began.

But the banks’ capital needs were based on unrealistic economic projections. Some have proved too rosy, others too grim.

For example, the test envisioned unemployment reaching 8.9 percent this year; it stands at 10.2 percent.

On the other hand, the tests assumed housing prices would fall 22 percent this year in a worst-case scenario. Instead, they fell 5.5 percent in the first half of the year and have risen for the past three months.

Earlier this year, the Obama administration subjected the 19 largest banks to “stress tests.’’ The goal was to boost confidence in the financial sector by showing how strong banks’ balance sheets were. Regulators used a series of economic projections to see if banks could withstand the losses they would suffer in case of a deeper-than-expected recession.

But the recession diverged far from the economic projections used. Analysts say their results reveal little about what troubles the banks now face. Though conditions have improved since the depths of the credit crisis, some analysts say certain banks face problems the stress-test buffers might not solve.

“We’re already at record numbers on losses, and those numbers are rising,’’ said Christopher Whalen, managing director of Institutional Risk Analytics.

The test results in May found that 10 of the 19 largest banks needed more capital to withstand losses they would suffer if the recession worsened. They were given six months to raise a total of $74.6 billion of capital. The Federal Reserve said yesterday that they have raised a total of $77 billion.

Whalen said if the banks approach losses the tests envisioned, they still might not have enough capital to stay afloat.

The only bank that did not raise the required capital was GMAC, which is weighed down by bad mortgage loans but provides financing to auto dealers and buyers. Regulators had said GMAC needed to raise an additional $11.5 billion.

The company is in talks with the Treasury Department about getting a fresh bailout from the $700 billion financial rescue fund. It is unclear how much money it will require. But Secretary Timothy Geithner said it “is expected to be lower than anticipated’’ when the stress test results were announced.

Geithner said the success of the other 18 companies showed that the financial sector has become far more stable since January. But Whalen said that despite government subsidies, banks like GMAC and Citigroup Inc. still are too troubled to extend credit and support an economic recovery.

“These are zombies and they can’t make loans,’’ he said. “None of this is helping the real economy.’’