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The Banking “Stress Tests” Explained…by Timothy Geithner

May 7, 2009

At the New York Times, Treasury Secretary Timothy Geithner has an editorial explaining the Obama administration’s response to the financial crisis and an excellent description of the “stress tests” that the Treasury department has been running on the banks to determine their soundness. An excerpt:

The Federal Reserve marshaled hundreds of supervisors to spend 45 days rigorously reviewing the banks’ detailed loan data. They applied exacting estimates of potential losses over two years, along with conservative estimates of potential earnings over the same period, and compared them with existing reserves and capital. The results were then evaluated against strict minimum capital standards, in terms of both overall capital and tangible common equity.

The effect of this capital assessment will be to help replace uncertainty with transparency. It will provide greater clarity about the resources major banks have to absorb future losses. It will also bring more private capital into the financial system, increasing the capacity for future lending; allow investors to differentiate more clearly among banks; and ultimately make it easier for banks to raise enough private capital to repay the money they have already received from the government.

The Obama administration receives tremendous criticism from the right and there is a growing chorus claiming that his efforts to address the economy are actually a stealth campaign to increase his power and install a socialism and government control over this country against the will of the people. Of course, some of this is rabid paranoia unattached to any real knowledge of the Obama administration’s actions. But for those who feel a growing unease at the vast amounts lent to banks, the virtual nationalize of the car industry, the mico-managing of Wall street and the like, it is important to remember three things: (1) the economy was left in a state of systemic collapse by the time that Obama was sworn in and (2) that little of his major economic initiatives would have been undertaken had the economy been in anything less than a catastrophic state of failure and (3) his response to the crisis, as indicated in the steps taken to stress test the banks, shows not a wild and unfocused move towards government control and unsustainable spending but a measured and remarkably restrained response to an historic economic collapse. Geithner describes a tightly focused plan to ensure the continued existence of the banks and their ability to lend money…the one factor that could most help pull our country and economy out of the recession.

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