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Three Banks and One Insurer Fail Fed’s Stress Test

This article was written by in Economy. 7 comments.

After the recession, the Federal Reserve developed a stress test for banks and financial firms too big too fail. The stress test looks at the financial condition of these corporations and simulates a new recession. Under the simulation, based on a worst-case scenario, not an actual economic forecast, banks pass the test if the companies have sufficient capital to continue lending; if not, they fail.

Here’s the doomsday recession scenario or assumptions applied to the banks’ financial condition:

  • An unemployment rate of 13 percent.
  • A 50 percent drop in the stock market.
  • A 21 percent drop in the real estate market.

Citi Checking Account Piggy BankThis scenario, which isn’t a prediction for the future, is non far-fetched. The recession in 2008 produced similar or worse results in the stock market and housing prices.

Overall, the banks fared better with this year’s test than with last year’s same analysis. The improvement is due to increased capital at the corporations. The companies lowered dividends to keep more money on hand for emergencies.

While fifteen of the nineteen banks were found to have sufficient capital to withstand the recession without assistance, four bank holding companies or financial institutions in the test failed to meet the capital requirements: Ally Financial, Citigroup, SunTrust, and MetLife.

Officials from the banks quickly responded to the Federal Reserve’s results.

Citigroup said it remains among the best capitalized large banks in the world. However, it said it would not be able to raise its dividend as it hoped, and would submit a revised capital plan to the Fed. Ally said it supported the idea of stress tests, but it disagreed with a number of the assumptions the Fed made, including overstating the bank’s potential mortgage losses. SunTrust could not be reached for comment. Metlife said it was unfair to apply the same tests to insurers as it did to banks.

These companies’ failures isn’t too concerning for customers. Customers shouldn’t be worried that their savings accounts aren’t safe or their insurance policies are in danger. No one has ever lost money in an FDIC-insured bank account. If these corporations don’t improve their financial situation by raising more capital or paying less to shareholders, a recession might result in more government intervention in the companies’ continued operation. The lack of sufficient capital in these financial institutions might lead to another bail-out scenario.

While not concerning from a personal perspective, there is reason to be somewhat concerned with the Federal Reserve’s findings. Financial institutions haven’t adequately planned for systemic risk. When banks fail or need a government bail-out, capital infusion, or partial nationalization, all taxpayers are affected. Shareholders need to be concerned. Will the recent bail-outs still fresh in people’s minds, the public and policymakers have likely lost its appetite for using taxpayer money for assisting banks that are “too big to fail,” and might rather see a firm like Citi go bankrupt rather than submit to a government takeover.

Federal Reserve

Published or updated March 14, 2012.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 7 comments… read them below or add one }

avatar 1 Anonymous

Citigroup seems to have decided to stop paying someone off and they keep getting punished for it. They have done things better or the same as other banks, yet they continuously seem to always be just short. You could argue that they need to improve things, which is probably true, but isn’t it interesting that the 5% capitalization mark was set just above the 4.9% that Citi came up with. If they’d come in at 5.4%, the Fed probably would have set the threshold at 5.5%. I’ve watched this stock get manipulated with jawdropping regularity over the past year so much that it makes me laugh now and I can’t just think that all of Citi’s ‘failures’ are on the back of Citi. Someone has a vendetta against them.

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avatar 2 Luke Landes

Well, 5% Tier 1 common capital ratio was the same benchmark used in last year’s stress test… but the Federal Reserve doesn’t seem to be offering last year’s detailed results at the moment.

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avatar 3 Ceecee

Would this could have an affect on the bank stocks? Yesterday Chase rocketed up after they passed the test and raised the dividend.

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avatar 4 Luke Landes

I imagine it would have a direct short-term effect on the stock prices for banks involved in the test. Chase’s passing of the test and the announcement of the dividend made that stock more attractive, I’m sure. Citi’s price dropped when the market opened this morning, and that could be investors’ reaction to that bank’s lower score in the stress test.

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avatar 5 Anonymous

In reality the passing grade – allowed – the banks to increase their dividend, something that the government wasn’t allowing before. Citi’s drop may very well be due to the fact that by failing, their future dividends are still restricted, while other bank stocks are indeed more attractive. More importantly the banks are still being allowed to avoid mark-to-market accounting for mortgage products/holdings, so their earnings statements, balance sheets and passing grades are more akin to Enron’s than we’d like to think.

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avatar 6 Anonymous

It will be interesting to see how this all plays out. The public is ready to let some fail that are TBTF. Ally is not doing too well for all their positive ads and many people putting accounts there. I suspect it’s the old inheritance from when they were GMAC financing. I’m hoping they can get their house in order.

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avatar 7 wylerassociate

I am still skeptical about this. I know that financial stocks soared but I have my doubts about the liquidity of these banks especially when another financial crisis hits.

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