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Stress Test Results Shed Light On Banking Sector

RENEE MONTAGNE, host:

It's MORNING EDITION from NPR News. Steve Inskeep is in Kentucky today to address graduates at Morehead State University. I'm Renee Montagne.

And America's biggest banks have finally gotten the grades on their stress tests. The Treasury Department ordered those who didn't do well to raise a total of $75 billion. The stress tests were aimed at assessing the health of the financial system. Among those required to raise more capital, Bank of America, Wells Fargo and Citigroup. And if they do that, the country's top financial officials say the banking system should have enough of a cushion to get through the recession.

NPR's Chris Arnold reports.

CHRIS ARNOLD: For the first time, the government has laid out which banks it thinks are in better shape, and which ones are on weaker legs. That's what the stress test is all about. Simon Johnson is a professor at MIT and the former chief economist for the International Monetary Fund.

Professor SIMON JOHNSON (MIT): Well, a stress test for a banking system is very much like a stress test for your heart. You go to the doctor, the doctor says get on the treadmill, we'll make your pulse rate go up a bit and pump some blood around and see how the heart handles that. So you can't quite do that with banks.

ARNOLD: But what you can do is look at scenarios where banks would suffer more losses. You can calculate what would happen to the banks if the recession got worse, and a lot more loans went bad.

So if the recession gets really, really ugly, it's like making the treadmill go really, really fast and slant upwards and see if the banks are going to fall off and clutch their chest or not, right?

Prof. JOHNSON: Exactly right, so the stress test is all about how hard you push the patient.

ARNOLD: More on just how tough this test was in a minute. A few months ago, though, just the very idea of this kind of a test for banks sent investors fleeing from financial stocks. This was back when Treasury Secretary Geithner gave his first big speech on what the new administration was going to do to fix the banking system.

Mr. DAVID KOTAK (Cumberland Advisors): The speech was a bomb. It laid an egg.

ARNOLD: That's David Kotak, the chief investment officer of Cumberland Advisors. He advises large institutions on how to invest their money. He says that back then, the administration said it was going to get the banks on the treadmills, but it didn't offer any details about how rigorous the tests were going to be or what the consequence of failure would be.

Mr. KOTAK: The markets and the investors and observers around the world wondered if the banking system would survive, and if it needed to be nationalized. There was a big unknown. It was like a black hole.

ARNOLD: Kotak says over the past four or five weeks, though, details have been steadily leaking out, and that helped to encourage investors. The government says it took a hard look at 19 banks, and it says some need to raise a total of $75 billion. That's not good, but it's not as bad as some people feared, and Kotak says the stress tests show that the government thinks the banks are likely to make it through the recession.

Mr. KOTAK: I would expect almost all of the banks to survive.

ARNOLD: The government is hopeful that it won't need to authorize even more taxpayer money for bank bailouts. And the banks that need more cash are now scrambling to raise it. Bank of America was ordered to raise $34 billion. It could sell common stock, and sell off some other companies and assets that it owns. Citigroup's CEO, Vikram Pandit…

Mr. VIKRAM PANDIT (CEO, Citigroup): I'm kind of glad the results have been announced and that this process is behind us. Our plans and actions will give Citi the financial strength to endure an adverse economic situation.

ARNOLD: Still, some economists think that the banks may need more additional help than the government is forecasting. Simon Johnson doesn't think the stress tests were tough enough, and other economists agree.

Professor PETE KYLE (University of Maryland): It is a very soft-ball stress test.

ARNOLD: Pete Kyle is a finance professor at the University of Maryland.

Prof. KYLE: The stress test used a bad scenario laid out by the government. That bad scenario seems to be what we're following now. I think it's quite possible, maybe not likely, but quite possible that things could get worse. Banks are going to need more capital, and they're going to come to the government to get it because the public markets are not going to want to give it to them.

ARNOLD: Kyle thinks the government should be pushing harder for the weaker banks to convert the money it's already given to them into common stocks. The takeaway there, he says, is that that would help prop up the banks, and he says taxpayers would get more upside if the banks recover.

Chris Arnold, NPR News. Transcript provided by NPR, Copyright NPR.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.

NPR correspondent Chris Arnold is based in Boston. His reports are heard regularly on NPR's award-winning newsmagazines Morning Edition, All Things Considered, and Weekend Edition. He joined NPR in 1996 and was based in San Francisco before moving to Boston in 2001.