It's a day that could dictate the direction of the stock market for some time to come, and could even radically reshape the nature of the relationship between the United States Government and the banking sector.
Stress Test Day.
The Federal Reserve has begun privately releasing the results of the so-called "stress tests" it performed on the 19 largest US banks. The purpose of the tests was to determine which of the financial institutions required government assistance, which could be saved, and which must fail.
Some top regulators have written that there is a strong chance that the US government could end up acquiring significant stakes in banks according to how the stress tests go and the rate of economic recovery. The Fed is only communicating the results to the banks themselves, and previously circulated a letter requesting that the banks stay quiet about the results until the public release of the report on May 4.
The Fed obviously wants to avoid any deleterious effects on the banks that don't perform well on the tests, reasonably assuming that investors and depositors would likely lose confidence in those banks and move their money elsewhere. That could cause banks that are on already shaky ground to lose their footing entirely.
Which makes one wonder why the Fed is releasing results of the tests and the methodology at all, but after the considerable amount of backlash that occurred when it looked like they were going to keep everything under wraps, they almost didn't have a choice.
So far, however, the release of the methodology and The Fed's limited statements haven't really pushed the markets in either direction, which has pleased industry insiders. CNBC quotes Scott Talbott, senior vice president of the Financial Services Roundtable, as saying that "'[w]e like [the methodology]; we think it is consistent in terms of assumptions and
application. At the same time, it doesn't give you
the ability to be an armchair regulator and run the numbers on your own
and create uncertainty in the market place."
The Fed applied two different scenarios to the banks' books: one
assumed that the current projections about the recession would hold,
the other examined a more dire scenario. Many commentators have said that recent economic data point to the latter as the more likely of the two.
Which is why it's only slightly reassuring that the Fed stated as part of the release that most banks are well-capitalized, but need to hold substantially more capital in reserve than required under current regulations to hedge against the possibility of a worsening recession.
See Also: Bank industry to hear results of 'stress tests' (AP) Sobering Numbers Ahead of Stress Test Results (DealBook Blog) Bank industry to hear results of ' stress tests' (Huffington Post) US bank stress test results to call market's tune (Reuters)