I had a stress test once. It was more of a routine test because my family has a history of heart problems. Being a runner, I thought for sure that I would make those doctors miss lunch I was able to stay on the treadmill for so long. It really is simple. They start an IV in your hand and inject some magical die so a machine can see pictures of your heart. Then they put you on a treadmill and make you walk. Easy, right? Well, no because they put quite an incline on the treadmill. It’s tough and this overconfident runner didn’t stay on the treadmill nearly as long as he thought he would.
Congratulations! Now you understand the stress test that the banking sector has been going through thanks to the U.S. Federal Reserve. The premise is simply, really. Put the nation’s largest bank through some scenarios like catastrophic unemployment rates, further decline in home prices, and stock market crashes. By setting up some fake scenarios and applying those to the banks’ balance sheets, the Fed can have a pretty good idea the financial strength of that bank. This is nearly exactly the same as the stress test that checked the strength of my heart.
Why did The Fed do the stress tests? The reasons, the methodology, the results, and the everything else has been less than public. Nobody is talking much about it so we don’t know for sure but we can guess. First, to the naked eye all we can do is trust each bank to tell us if they are insolvent or not. We really don’t know how strong they are and as we have learned far more than once, we can’t trust the banks to tell us until the problems are critical.
Next, we can assume that The Fed is trying to give itself a bit of an insurance policy. If they can determine which banks will survive the worst financial stresses, they know who to infuse cash in to and which ones should fail.
What action will take place as a result of these stress tests? The answer is simple: We don’t know. Probably nothing especially since banks are slowly improving but on March 10th, The Fed instructed all banks not to disclose the results of the stress test.
Good news! My heart is strong and I passed my stress test with flying colors. I don’t think all of the banks will come in this good but the good, or maybe bad news is that we may not know for a very long time if ever.