WASHINGTON — It seems every day there is a new rumor about the results of regulators' stress tests of the 19 largest banks, ranging from promises that they all passed to dire predictions that they all failed.
But there is little doubt these tests are now critical to the government's rescue efforts. President Obama was scheduled Friday to discuss the results with Treasury Secretary Timothy Geithner, Federal Reserve Board Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairman Sheila Bair and Comptroller of the Currency John Dugan.
Exactly what regulators have found or what the results mean is murky, so we offer the following frequently asked questions.
Are all the banks going to pass these tests?
It depends on how you define failure. Some regulators are denying that any institution can "fail" the stress test. To them, the tests are only designed to say how much additional capital an institution would need under various economic circumstances. So a bank could need tens of billions of dollars in additional capital and still be said to have "passed" the test.
Are people going to buy that?
Not likely. Regulators are already skating on thin ice in terms of credibility, and claiming that banks that require billions in capital are healthy isn't likely to engender much confidence. Investors and industry analysts have already formed their own definitions of failing, and, roughly speaking, it's this: if a bank needs a lot of capital, it failed the stress the test.
So what did the tests determine?
It's unclear what regulators will actually reveal, but at least one source said the results of the tests were worse than expected. That has left regulators debating exactly what they should tell the public, and whether they should even change the terms of the test to make the situation look better.
So the agencies are fighting again?
According to multiple sources, the Office of the Comptroller of the Currency thinks the stress test process is a waste of time. Agency officials see it as arbitrary and a way of putting a rubber stamp on giving some of the largest banks more government money. They also think the banks themselves are doing just fine — it's the holding companies (which are not in the OCC's jurisdiction) that are in trouble.
The Federal Deposit Insurance Corp., meanwhile, sees the stress test as a way to push for tougher action against certain institutions. For example, banks that show a capital shortfall should be forced to sell toxic assets to the government's public-private partnership funds, according to the FDIC.
It's unclear where, exactly, the Federal Reserve Board is in all of this, but according to sources using typically cryptic Fedspeak, it has a more "benign" view of the stress tests than the other agencies.
How many banks will need more capital?
We really don't know yet, and it's unclear when we will. Regulators have pledged to release some information publicly by the end of the month, but are trying to keep the results under wraps. But the banks that do not need additional capital are almost certain to try and find a way to convey that information to investors, which will make it easy to infer which institutions need more capital.
So who is going to give those banks more capital? The government?
Yes, but only after we go through a pantomime play where the banks ostensibly seek more money from the private sector, which is in fact too scared of government intervention to give them any. This could last for as long as six months, the deadline set by the government for raising outside capital. After that point, the government is expected to pony up.
What's up with that six-month deadline? What is supposed to happen during that time?
It's a play for time. The hope is that after a few months, the private-equity markets will be more willing than they are now to invest in banks. Regulators also can hope the banks' situation improves, making it easier for them to attract private support. Whether the economic situation will actually improve during that time, however, is anyone's guess.
What else will they do if banks need more capital?
Regulators will probably force some banks to sell assets through the toxic-asset plan. They could also force management changes and require additional warrants or stock purchases. Considering the uproar over executive bonuses, it's a given that harsher executive compensation restrictions will also apply.
That sounds familiar.
With the exception of the toxic-asset program, that's pretty much the playbook since October. Taking out a CEO of a large bank could have some impact. Since the government forced out the head of General Motors, there have been growing calls to oust a bank CEO. The stress test results could provide a good excuse to do so.
What exactly were the stress tests anyway?
Under the tests, the performance of the 19 banks that have more than $100 billion of assets was tested under two scenarios: a baseline reflecting consensus economic expectations and a more adverse scenario. Both would specifically project gross domestic product, the unemployment rate and changes in housing prices. Under the more adverse scenario, the test assumes a GDP of negative 3.3% in 2009 and a gain of 0.5% in 2010, an unemployment rate of 8.9% in 2009 and 10.3% in 2010 and house price declines of 22% in 2009 and 7% in 2010.
Where did they get those numbers?
Out of thin air. Economists are already debating whether they are sufficiently dire to really predict if banks are holding enough capital. Regulators, meanwhile, are discussing whether the numbers are too tough.
You don't sound very positive about this.
From the beginning, the point of the capital stress tests has been unclear. Regulators already have access to tons of information about banks, and it is debatable if the stress tests are telling them anything they don't already know.
If the point is to reassure the public that these banks are in sound shape, the actual results could do the opposite. Even President Roosevelt, when he implemented his bank holiday in the 1930s to scrub banks' books, shut several banks down before declaring the rest in good shape. If regulators simply declare all 19 banks have passed their stress test, it will seem like little more than a stunt.
And it is likely to backfire. If the public believes the stress tests are a stunt, it will only further undermine the dimming faith they have that the government has the wherewithal to get them out of this mess.