The stress tests are out. The results helped to send Bank of America
JPMorgan received permission to increase its dividends and stock buybacks. Bank of America soared after it didn't fail the tests. Of course, the test parameters focused on the results of hypothetical economic conditions, rather than worst-case losses from its legal challenges.
Of the 19 institutions tested, Citigroup
Too-big-to-fails Wells Fargo
Despite lobbying from the banks to keep details of the results secret, the Federal Reserve went ahead and released lots of useful information. Here's how the 19 fared:
The blue amounts are losses under the test's scenario; red is how much capital would be left over after the carnage.
Although banks would take big losses on their mortgage, credit card, and commercial and industrial loans, the biggest source of losses would come result from trading and counterparties, which should remind us all that a strong Volcker Rule is so important.
Now, the test had its limitations. For one, the worst-case assumptions modeled a more severe recession than the one we just had -- mortgage losses, high unemployment, gross domestic product decline, and low interest rates. Kudos for using much more stressful assumptions than in the flimsy 2009 tests. And given the liquidity trap we're in, it makes sense that a hypothetical double-dip recession sometime over the next few years would be deflationary rather than inflationary, just like the last one. But hopefully in future tests we'll also get to see how well banks would cope with alternative kinds of financial crisis. At the very least, it would be nice to see what affect moderately rising rates would have.
More importantly, as FDIC Chair Sheila Bair recently pointed out last week, the test looked at risk-based capital levels. Future versions of the test should look at overall leverage, too, since "risk-based" can be a somewhat squishy metric.
Furthermore, the tests, which focused on solvency, aren't a guarantee that we won't see another financial panic, with a shadow banking run once again crashing the entire system.
It's encouraging to see banks performing decently under the tested scenarios, since solvency would decrease the odds that we'll have to undergo another financial crisis and possible bailout during the next recession. But we still have a long way to go to protect ourselves from the next crisis.
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