Banks Won Concessions on Stress Tests

Yves Smith, for example, says:

But the stress tests fell far short of the needed level of review. First, they were administered by the industry based on scenarios provided by the industry. Most observers found the “adverse” case to be too optimistic. Even worse, banks got to use their own risk models, the same ones that got them into trouble. And there was no independent verification of the quality of the accounting. The number of examiners per bank was well short of what you’d need to probe a single business, much less an entire firm.

Second, the industry got to negotiate the results. This is simply unheard of. That suggests both a lack of confidence in the process and a lack of belief on the part of the key actors (Treasury Secretary Timothy Geithner, in particular) that the government needs to set the parameters and demand compliance.

William K. Black said:

Bottom line: there were no real examinations. Banks continue to overstate asset quality. The bankers pressured Congress, which extorted the Financial Accounting Standards Board, which gutted the accounting rules on loss recognition. Because there were no real examinations, there were no real stress tests. So only one question is key: why does Treasury believe that anyone will believe its compound fiction?

Simon Johnson said:

The handling of the stress tests shows the administration prefers to adopt a “wait and see” policy toward banks. If the economy recovers, this will help the banks get back on their feet. If the economy doesn’t recover, more subsidies for banks will soon be in the mail.

Bert Ely said:

The stress tests have been harmful in two regards. First, the Treasury white paper describing the tests was so vague as to undermine the credibility of the tests. Consequently, the stress test results may lack credibility, too, especially if enough investors believe that they paint too rosy a picture of the financial condition of those banks seen as the most troubled.


An Insufficient Effort

The bottom line is that these "stress tests" are a joke and have been chock full of yet more violations of the law. Reg-FD is supposed to mandate that material information is released to everyone at the same time. But that of course isn't what has happened; there has been leak after leak after leak, some of them false. Will we see indictments? Of course not, given that most of the leaks are coming from the Treasury itself, and are being used as a means to pump up asset prices!

Testing The Panic Of Bank Insolvency

The report, prepared by Essential Information and the Consumer Education Foundation, details step-by-step many of the events that led to the financial debacle. Here are the “highlights” of our economic downfall:

• Beginning in 1983 with the Reagan Administration, the U.S. government acquiesced in accounting rules adopted by the financial industry that allowed banks and other corporations to take money-losing assets off their balance sheets in order to hide them from investors and the public.

• Between 1998 and 2000, Congress and the Clinton Administration repeatedly blocked efforts to regulate Industry “financial derivatives” — including the mortgage-related credit default swaps that became the basis of trillions of dollars in speculation.

• In 1999, Congress repealed the Depression-era law that barred banks from offering investment and insurance services, and vice versa, enabling these firms to engage in speculation by investing money from checking and savings accounts into financial “derivatives” and other schemes understood by only a handful of individuals.

• Taking advantage of historically low interest rates in the early part of this decade, shady mortgage brokers and bankers began offering mortgages on egregious terms to purchasers who were not qualified. When these predatory lending practices were brought to the attention of federal agencies, they refused to take serious action. Worse, when states stepped into the vacuum by passing laws requiring protections against dirty loans, the Bush Administration went to court to invalidate those reforms, on the ground that the inaction of federal agencies superseded state laws.

• The financial industry’s friends in Congress made sure that those who speculate in mortgages would not be legally liable for fraud or other illegalities that occurred when the mortgage was made.

• Egged on by Wall Street, two government-sponsored corporations, Fannie Mae and Freddie Mac, started buying large numbers of subprime loans from private banks as well as packages of mortgages known as “mortgage-backed securities.”

• In 2004, the top cop on the Wall Street beat in Washington — the Securities and Exchange Commission — now operating under the radical deregulatory ideology of the
Bush Administration, authorized investment banks to decide for themselves how much money they were required to set aside as rainy day reserves.

Some firms then entered into $40 worth of speculative trading for every $1 they held.

• With the compensation of CEOs increasingly tied to the value of the firm’s total assets, a tidal wave of mergers and acquisitions in the financial world — 11,500 between 1980 and 2005 — led to the predominance of just a relative handful banks in the U.S. financial system.

Successive administrations failed to enforce antitrust laws to block these mergers. The result: less competition, higher fees and charges for consumers, and a financial system vulnerable to collapse if any single one of the banks ran into trouble.

• Investors and even government authorities relied on private “credit rating” firms to review corporate balance sheets and proposed investments and report to potential investors about their quality and safety.

But the credit rating companies had a grave conflict of interest: they are paid by the financial firms to issue the ratings. Not surprisingly, they gave the highest ratings to the investments issued by the firms that paid them, even as it became clear that the ratings were inflated and the companies were in precarious condition.

The financial lobby made sure that regulation of the credit ratings firms would not solve these problems.

None of these milestones on the road to economic ruin were kept secret. The dangers posed by unregulated, greed-driven financial speculation were readily apparent to any astute observer of the financial system. But few of those entrusted with the responsibility to police the marketplace were willing to do so. And as the report explains, those officials in government who dared to propose stronger protections for investors and consumers consistently met with hostility and defeat. The power of the Money Industry overcame all opposition, on a bipartisan basis.