Results of the Federal Government's Own Stress Test

We’ll soon know the results of the federal government’s stress tests of the 19 largest banks in America. What we already know, in a sense, are the results of the federal government’s stress test of itself.

Last week, Treasury Secretary Timothy Geithner made clear that banks participating in TARP (which would include just about all those undergoing stress tests), would not be allowed to repay the federal government’s TARP money except if the government allowed it. In other words, once a big bank is in TARP, it doesn’t get to choose the timing of its exit even if it believes it can repay the loan.

One could observe that made guys don’t get to leave the mob just because they feel like it. Indeed, some people believe the federal government is a form of organized crime. But we don’t wave telescopically sighted rifles from ridges and won’t advocate that point of view.

What this no exit (except with our approval) policy reveals is that the financial system remains fragile. If a couple of major banks leave the TARP program, that would imply that the banks remaining in TARP are weak. The latter would be vulnerable to runs, and the federal government seems to be saying that it might have an awfully hard time coping with another run on the banking system. Recall that the last run, after Lehman collapsed, required the ever-more expensive bailout of AIG. Basically, it took a blank check drawn on the United States to prop up the financial system. While members of Federal Reserve Board and other government officials have been dropping hints of the economy sprouting green shoots in a drought, the truth seems more like a Jackson Pollack splatter without the expressiveness than a clear picture.

The bank stress tests are a political event. They are being conducted under the supervision of the Secretary of the Treasury, not the independent bank regulatory process. Evaluate their results with that in mind.