Should bank stress test results be public?
24 April
Today the 19 largest banks are getting the results of their stress tests from their regulators. Should these results be made public?
This is not a simple question.
The big upside is that markets will have more information, and that all market participants will have access to the same information. This can allow investors, counterparties, and customers to evaluate the health and stability of the banks with which they are doing business. I have a default presumption that more information more widely disseminated is a good thing.
Downside 1: Some banks might be just above the bubble but rank low. They may still be healthy enough to survive and eventually succeed, but if they are disclosed to be among the weakest, that disclosure may cause a run of depositors, counterparties, or investors. This could push some marginal banks over the edge and cause them to fail.
This is not a trivial concern. Last September there were reports that investors were “testing” even the clearly healthiest investment banks (JPM Chase, Goldman Sachs) shortly after Lehman’s fail. Senior policymakers remember that vividly, when panic might have destroyed banks that on paper were solid. From the perspective of the policymakers who have the information, it is easy to understand why they may be highly risk averse. From their perspective, not disclosing the information may appear to be the safer course.
There is a response to this downside. Banks that do well in the stress tests have an incentive to let the world know that. It may be hopeless for policymakers to think they can protect the weaker banks by not having the government release the information, because the strong banks will do it implicitly by shouting their good news.
Downside 2: The stress tests might not be well-designed. If they are poorly designed, overly optimistic, or just misinterpreted by the market, then the government could be injecting bad information into the market. Government may not be smart enough to design the tests to provide enough useful information to the markets.
More importantly, any stress test is highly imperfect, and there is a risk that the results would create a sense of false certainty. I read a lot of market commentary while working in the White House, and was amazed at how frequently high-level market commentaries completely misinterpreted or misread data that we released (much less policy statements).
This is a close call, and people whom I respect advise in different directions. I fall back on my default presumption / instinct, which is to release the information. There is a small probability of a really bad outcome (a panic/run), and a much larger probability of a good outcome with no run and somewhat better informed markets. I also think it is easy for policymakers to overestimate the amount of control they have over the situation.
The Wall Street Journal reports the following game plan:
- Today the regulators are giving results to the banks privately, and asking them not to disclose them. They are also releasing the test methodology.
- 10 days from now, the regulators will release results of the stress tests, although “regulators also have not decided how much information will be disclosed May 4.”
On the whole, this game plan makes sense to me. I am not sure they will be able to hold out for 10 days, and my instinct is that they should release more information rather than less. I hope market participants will take the time to understand just how imperfect this information will be.
By the way, I presume that the decision to leak that they expect to release the results was made after they knew the results of the tests. This suggests that the results are generally good. If the stress tests showed that half of the banks would fail, I presume they would not be signaling a future release.
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Well, if a bank willingly took and wanted TARP funds I don’t know how they can get around making the results known. After all this administration is supposed to be all about transparency. But if a bank hasn’t taken the TARP money then I don’t think they need to be made public unless the bank wants it.
Of course your second point is highly valuable. I frankly will not be surprised if the data is that the banks are for the most part doing fine. That is a perception the government needs the populace to believe whether it’s true or not.
Though looking at Wall Street today they are reacting to the news by running the markets up. The cynic in me thinks that once they get time to digest things come Monday, the market will be tanking.
Interesting to note though that while the DOW is rising, I see from the widget http://www.learcapital.com/exactprice that gold and silver are also going up. I would have expected a fall there with the DOW rising. Could be that China has been buying up gold.
Strange days.
You’ve made a great case for transparency on stress test results, and I strongly agree.
What I find troubling, although not terribly surprising, is that one result of the stress test will be that the federal government will snap up more common stock shares of major banks. The government already is Citigroup’s largest shareholder. According to this morning’s WSJ, it will not be the last.
The paper quotes a draft report of the Financial Stability Oversight Board as saying, “the government has the potential to acquire a substantial portion of the outstanding common shares of a participating institution.” It adds, however, that “Treasury will maintain the goal of keeping the period of government ownership as temporary as possible.” Very reassuring.
If this report is accurate, the government’s actions may do more to spook investors than merely releasing the results of the stress tests.
Keith,
This is irrelevant to this post, but I’ve been hearing (on Bill Bennett’s show) that the Dems have decided to use reconciliation to do health care.
Count me scared. What exactly have they done? Do they have an actual conference report yet? Has it got the Byrd bath? If so, what’s in the bill, exactly? Are those things in there you predicted wouldn’t survive the bath?
Help!
Keith,
Are you going to do a report soon on the results of the Bank Stress Tests and what that means?
Also, it would be great to read your opinion on the current state of the banking industry. It has been over 6 months since the first TARP was handed out. Have we improved the situation? Have the banks and their assets / leverage ratios become more stable? Are there any banking indicators that show banks and the banking system are improving, worsening, or stagnating.
Thanks.