Commentary | Economic Growth

Greater transparency in stress test results is a good start;  more is needed

There is plenty to be skeptical about in the bank stress test results being released today, but one positive development should not be overlooked: The Treasury Department and Federal Reserve have made an unprecedented show of transparency in naming banks deemed to be undercapitalized.

To be sure, the famously-secretive Fed was prodded to do so by members of Congress, who didn’t buy the argument that disclosing such information could itself cause a fatal run on distressed banks. As it turns out, that did not happen. In fact, all bank stocks soared on the (perhaps overly optimistic) news that the 19 mega-banks studied by Fed supervisors are currently solvent, though some need to raise capital for a worsening economic scenario. 

The market – like taxpayers and consumers – thrives on more, not less, information, even when it’s not entirely positive. 

This is a good step toward transparency, although much more needs to be done. The Special Inspector General of the bank rescue program, Neil Barofsky, has stated repeatedly that federal bank rescue programs are ripe for abuse without a free flow of information. This is particularly true of the Public-Private Investment Program, or P-PIP, an invention of Treasury Secretary Timothy Geithner to buy up so-called toxic assets that are clogging the balance sheets of banks.

Geithner has said he hopes the test results will force Bank of America, Citigroup and others to sell those clumps of bad real estate loans and securities at reasonable prices – which will mean accepting big losses, and then moving on. That is precisely what financial experts around the globe are advising as the fastest and cleanest way out of this financial mess.  

However, it’s not likely to be sufficient. The stress tests may not have been sufficiently tough, and regulators have made it too easy for banks to raise capital by converting U.S.-held preferred stock to common shares. 

Congress is also to blame, by pushing for accounting rule changes that have allowed banks to value some assets at above market value.

Today’s announcement will contain far more information than initially envisioned. It’s a good start, but there is still a long way to go.

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