- The Washington Times - Friday, April 24, 2009

WASHINGTON — Regulators trying to stabilize the financial system could unwittingly roil it when they explain their methods Friday for stress-testing the largest banks.

Officials will privately begin telling the largest 19 financial institutions how they performed. But investors will be scrutinizing the test methodology for clues about which banks are in trouble.

The results won’t be publicly released until May 4.

The slow-motion rollout is intended to blunt market reaction to the news of which banks are healthy, which ones could fail if the recession worsens and which need more money to survive.

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News reports, including a confidential outline of the tests first reported by The Associated Press this week, have led analysts to start handicapping which banks could fail. The speculation will intensify with Friday’s release of the test methodology.

“I’m worried about the overreaction — people selling every bank short and pulling out all their deposits and hiding their money in the mattress,” said Scott Talbott, a lobbyist with the Financial Services Roundtable, which represents the biggest financial firms.

Regulators are striving to release enough information about the stress tests to inspire confidence. But they don’t want to give analysts so much detail that they can run their own tests on the banks before the official release of results.

The stress tests subject banks’ balance sheets to two scenarios. One reflects current forecasts for the recession. The other assumes the recession will worsen, according to the document, produced by the Federal Reserve.

Officials also are examining the quality of banks’ loans, according to an industry official and a regulatory official who spoke on condition of anonymity because they weren’t authorized to discuss the tests publicly.

The goal is to see if banks have enough money reserved to withstand these losses. If they don’t, regulators will force banks to boost their capital, with private or government money, and will take other steps to strengthen their balance sheets.

Some experts fear the hypotheticals aren’t tough enough.

“The question is, will the market accept the stress test as a realistic case?” said Paul Miller, an analyst with Friedman, Billings, Ramsey & Co.

Recent economic indicators show the economy is approaching the more severe of the government’s two scenarios, Miller said.

And there also are risks in outlining a test that will be tough on some banks, said Lawrence Brown, an accounting professor at Georgia State University.

“The more information we get as to what those outcomes are likely to be … the more investors will drag down the banks aren’t perceived to be healthy,” said Brown, who studies market behavior.

Tension surrounding the announcements highlights the high-stakes nature of the stress tests, a centerpiece of the Obama administration’s plan for bolstering the financial system. For months, officials have put off questions about the banking system by saying they’re awaiting the test results.

When senior White House adviser David Axelrod was asked in an interview last week with The Associated Press about a separate plan to buy up banks’ assets, he replied, “Let’s see what happens once the stress tests are done and the capital needs of banks are determined.”

The delays have led investors to fret: If the tests show every bank to be strong, they will look like a whitewash and won’t be taken seriously.

Yet once investors can distinguish stronger from weaker banks, they could start selling off weaker banks that remain stable but might falter if the recession got much worse.

That’s led some experts to question whether public tests were a good idea.

“I think it just snowballed,” said Mark Williams, a former Fed examiner and risk manager. “By saying ‘we’re doing it,’ all of a sudden they have to provide this information, and they just increased uncertainty.”

That’s why officials have been so slow to announce the results of the tests, said Williams, now a finance professor at Boston University.

Giving the banks their test results Friday, more than a week before they’re to be released, is supposed to give them time to process the data internally. But it could lead to speculation and turbulence as information leaks out — especially from strong banks that wish to trumpet their results.

The Fed, which is overseeing the tests, asked banks not to reveal their results during quarterly earnings announcements. Regulators worry investors might run down banks without any good news to announce.

“Mostly, it was a buying-time strategy,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management and former chief economist for the International Monetary Fund.

Other analysts said one reason for the financial market volatility is that banks already are betting, through their own market trades, that each other’s stocks will decline.

Reaction to Friday’s announcement could help policy makers decide what the results announcement should reveal, Talbott said.

“They will release enough data to satisfy everyone to some degree,” he said, “but they have to try to minimize incorrect conclusions.”

Associated Press writer Nancy Benac contributed to this report.

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