Washington deserves plaudits for stress test success

Originally published in the Financial Times

Tuesday’s release by the Federal Reserve of the results of its annual round of “stress tests” of the 19 largest American banks was yet another confirmation of the deftness with which the US government has handled the financial crisis.

In stark contrast to the feeling of ennui that has often accompanied Europe’s initiatives to shore up its own financial system, the latest news from Washington was greeted with enthusiasm, with share prices jumping 1.8 per cent by the end of the day and the S&P financials index up by 3.9 per cent.

The positive reaction is but the latest in a string of successes for US policymakers since the bankruptcy of Lehman Brothers, which snapped the free market orientated administration of George W. Bush into action.

There is much to praise. The much-maligned $700bn Troubled Asset Relief Program provided in late 2008 a solid financial firewall and stemmed the tide of fear and near-panic that had surrounded the banking system. It even turned a profit for the US Treasury, which invested just under $205bn in 707 banks and has so far received about $211bn back.

Tarp was aided by a dizzying, but necessary, array of other assistance programmes, including guaranteeing money market funds and providing liquidity to frozen security securitisation markets.

A few months later, the bank stress tests, which were championed by Treasury secretary Timothy Geithner, achieved a number of critical aims. First, as Tuesday’s reaction demonstrated once again, they provided essential reassurance to global markets that have at times been deeply skeptical and fearful. Equally importantly, the first set of results, completed in the spring of 2009, stemmed calls for more drastic and ill-advised actions,
such as nationalisation and even liquidation of the largest financial institutions. And, to some degree, the success of the stress tests restrained the angry demands to lock up the bankers and throw away the key.

However, with the benefit of hindsight, some decisions might have been taken differently. In particular, providing Tarp and other forms of capital to the banks on quite cheap terms fuelled grievances that financiers have continued to get rich at the expense of taxpayers.

Clearly, the banking system is not yet perfect. Four banks failed the latest tests, most notably Citigroup, which said it would resubmit its capital plan, as required. However, even these failures must be seen in light of the severity of the stress test scenario, which assumes 13 per cent unemployment, a halving of stock market valuations and the kind of “market shock” that might be triggered by the collapse of a bank in Europe.

Pernickety commentators will no doubt continue to find fault with the handling of the financial crisis. But as we say in America, anyone can call plays from the grandstand. As someone who was on the field for a bit of the game, I offer only commendations to both the Bush and Obama administrations for their post-Lehman Brothers handling of a daunting set of challenges.