Bailout oversight panel: More stress tests, please

Should regulators subject bank balance sheets to further stress tests? That's the recommendation of the panel charged with overseeing the administration of the Treasury Department's bailout fund in a report to be presented to Congress today.

Critics of the tests have long complained they weren't tough enough or transparent enough to prove that financial institutions were healthy. The oversight panel, led by Harvard law professor Elizabeth Warren, seems to agree. But Treasury Secretary Timothy Geithner has publicly called last month's stress tests a "one-time" event, so any further examinations seem unlikely.
According to the report, regulators should inspect banks' assets again if unemployment exceeds the 8.9 percent average assumed in the stress tests or banks "continue to hold large amounts of toxic assets on their books." (The report is available here.)

In what would amount to a free pass to examine banks' balance sheets at will, regulators should also have the power to run tests anytime "in the future when they believe that doing so would help to promote a healthy banking system."

With unemployment already reaching 9.4 percent in ` and averaging 8.5 percent across the first five months of this year, it seems almost certain that the panel's criteria will be met. And, of course, there's little sign that banks are willing to shed troubled assets at prices outside investors are willing to pay.

Another concern: Regulators only looked for problems that could crop up before the end of 2010. Looming commercial real estate delinquencies may not surface until 2011 or beyond, the report said, putting a considerable risk outside the scope of the tests.

Completed last month, the stress tests ran 19 financial institutions through an obstacle course of rising unemployment, falling real estate values and stagnant economic growth. Ten of the banks tested, including Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC), were deemed to need nearly $75 billion in additional capital.

The oversight panel enlisted law professor Eric Talley and finance professor Johan Walden, both from the University of California-Berkeley, to assess the stress tests. While they generally praised regulators' work on the tests, the pair criticized the dearth of details about their methodology.

"Without this information, it is not possible for anyone to replicate the tests to determine how robust they are or to vary the assumptions to see whether different projections might yield very different results," the panel members wrote in the report.
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