We, meaning taxpayers and investors, are about to find out which of the nation's 19 largest bank holding companies are in good enough financial shape to withstand a deepening recession and which ones aren't. Assessing the banks' strength is the purpose of the stress tests whose results are supposed to be revealed after the markets close Thursday.
There has been some debate within federal regulatory agencies about how and how much of that information should be revealed. The argument against transparency is that too much information could cause a run on weak banks. We believe, however, that the agencies should disclose as much as possible.
While it is true that revelations about the weakness of some banks could cause their stock prices to suffer, making them even weaker, it also is true that withholding information about relatively strong banks also punishes them. If investors know which banks are in better shape, they should be willing to buy their stocks and make them even stronger. That, in turn, should make them more willing and able to make loans. Freeing up lending is, after all, the goal of federal banking policy. It is the credit freeze that has damaged, and continues to damage, the larger economy.
Besides, at the outset of the stress tests in February, the U.S. Treasury agreed to make capital available to the weak banks, should the tests require that they strengthen their positions. The Federal Reserve has explained that the banks will be required to create comprehensive capital plans and will have six months to raise that additional capital from private investors. If that proves impossible, the Treasury will make more funds available, or the banks can apply to convert existing preferred shares owned by the government into common stock. The banks also could be required to sell assets and cut costs.
Either way, the federal government has signaled clearly that these banks will not be allowed to fail.
At this point, no one knows what the market reaction to the stress test results will be. It's not just the banks' credibility that is on the line, it is also the credibility of the tests themselves.
If the reaction is negative, the Obama administration could face the prospect of having to raise additional bank bailout funds from an increasingly hesitant Congress and public. Or, the federal government may have to create an entity to manage a receivership. That prospect alone might make banks more willing to sell troubled assets.