You’re going to be hearing a lot about “the stress tests” during the next week, so we’re explaining why.
First off, the stress tests are an analysis conducted by the government on how healthy the nation’s 19 largest banks would be if the economy worsened. The banks under review received TARP (Troubled Asset Relief Program) funds last year, in some cases up to $45 billion.
On Friday the government will release details of the test methods used, and will reveal preliminary findings to each bank privately. Final, public results are expected on May 4.
Why are the stress tests so important?
The government says the stress tests will help determine: 1) if it’s ok for the banks to pay back the TARP money, or, 2) which banks may need more money to stay afloat. The banks will have until Tuesday to dispute the results.
The test results are important to the banks, some of whom would like to unload their TARP funds. Holding on to government money subjects them to potential restrictions on compensation and bonuses—something most banks want control of themselves. If the results reveal weakness, some worry that the government, which has shown a willingness to take shares in the banks, could require management changes like they did at General Motors.
The results will also likely be important to the markets, which are looking for signs of recovery in the financial sector.
How are the banks doing?
In the last two weeks several major banks reported that they made money in the first quarter of this year, giving some reason to feel encouraged that the industry is making headway toward stabilizing and pulling itself out of this quagmire.
The big picture
The stress tests are cause for stress between Washington and Wall Street. Banks want their autonomy and the government wants to ensure that the economy doesn’t collapse. Washington wants to know that there’s enough money at banks to keep loans flowing and avoid another freeze-up. But by refusing to take back TARP funds they maintain some power over the banks. You can bank on a battle once the results are released.
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