Stress Test Results Should Stay Private

April 15, 2009
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An article I read today mentioned that the federal government was contemplating releasing the results of the stress tests it is conducting on many of the nation’s financial institutions. Apparently, the government is taking a page from the Sen. Charles Schumer playbook on “How to create a run on a bank.

Last fall, when the government called the CEOs of the nation’s largest financial institutions into a conference room at the Treasury Department, it asked that all of them take funds from TARP. This was done to avoid creating a situation where the weaker banks — the ones that needed the money most — were identified by the large checks in their hands as they walked out of the building.

It may just be me, but don’t these two policies contradict each other, at least a little? I get that the two policies were created by two different administrations, and that President Obama is all about transparency. In most cases, sunlight is the best disinfectant. I’m all in favor, for example, of the Federal Reserve holding regular press conferences. Doing so would eliminate the market swinging wildly whenever Ben Bernanke engages in small talk at a cocktail reception.

But there is a reason that the FDIC did not start publishing the list of “problem” banks the moment President Obama finished the oath of office. There is still some information that has to remain private.

If the results of the stress test indicate that a financial institution does not have enough capital to weather further economic erosion, then it should be wound down. No more shotgun marriages, no more bailouts. Doing this will avoid having to prop up the institutions that are failing and also avoid inciting panic.

Should a bank choose to release the results of its stress test on its own, fine. But the government should not be in the business of publishing information that could incite a run on an institution.

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One Response to Stress Test Results Should Stay Private

  1. garyschurman on April 15, 2009 at 4:29 pm

    I never understood why there would be a run on a bank when the person doing the running is insured. If I were a depositor in 1929 (and was uninsured) then I can see wanting to be at the front of the line to close my account given that if I was at the end of that line I would get nothing. Today I don’t care because I am insured (I am ignoring the hassle of having deposits in a failed institution).

    And by the way, these are not bailouts. The media’s use of that word is flat out wrong! These banks should not be wound down, they should be propped up and there should be shotgun marriages for one simple reason…the taxpayer is the insurer (outright deposit insurance, increase in the deficit if the bank fails, pain and suffering, etc).

    Lets pretend that I have an insurance company and I’m insuring the life of John Doe for the term of one year. If John dies then the insurance company pays John’s estate the sum of $1 million. John is given 3 months to live. If John gets an operation then there is a 50% chance that he will not die in one year. The operation costs $400,000 and me, the taxpayer, is asked to foot the bill. Should I do it? That depends.

    If I don’t know John and have no financial interest in whether he lives or dies then I let him die because to fix John would cost me $400,000 and I get no benefit from that investment.

    That decision changes if me, the taxpayer, is the insurer of John’s life.

    I don’t pay for the operation.
    –He dies. The cost to me = $1,000,000

    Expected cost to me if I pay for his operation:
    –If he dies then it costs me $1,400,000
    –If he lives then it costs me $400,000
    –The expected value of that decision is $900,000 ($1,400,000 x 50% + $400,000 x 50%)

    I can make a case for footing the bill for John’s operation because that decision is the best one I can make because I am the insurer of John’s life. The same can be said of banks. If the taxpayer is the insurer of the bank (and they are) then the best decision to make might be to put capital into them so that they don’t fail. If at the end of the day I’m bailing myself out then its not a bailout, its an investment that makes sense. The current stockholders are wiped out or diluted and for me, the taxpayer, its the best decision I can make given the choice of two bad outcomes.

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