Bailout panel: bank stress tests need repeating

WASHINGTON (Reuters) - Bank stress tests should be repeated under more adverse assumptions and over a longer period because the worst-case unemployment rate used in recent tests will soon be exceeded, the head of the U.S. bailout watchdog panel said on Tuesday.

A trader works on the floor of the New York Stock Exchange March 18, 2009. REUTERS/Brendan McDermid

“We have not actually broken through the worst-case scenario, but let’s face it, the numbers are bad and they’re heading in the wrong direction,” Congressional Oversight Panel chairman Elizabeth Warren told the Joint Economic Committee of the U.S. Congress.

In a monthly report released earlier on Tuesday, the panel said the stress tests should be repeated periodically as long as banks continue to hold “appreciable amounts” of toxic assets.

Warren said the U.S. unemployment rate average for 2009, now at 8.5 percent, will soon exceed the 8.9 percent as the worst-case scenario used in regulators’ capital evaluations of the 19 largest U.S. bank holding companies. The unemployment rate for May was 9.4 percent and many analysts expect it to continue to climb.

“The worst-case scenario number for 2009 is in fact not the worst case. We’re going to see worse numbers,” added Warren, a Harvard Law School professor.

The monthly report from the panel said the stress tests, ordered by the U.S. Treasury Department for the top 19 U.S. bank holding companies, used a risk-modeling approach that on the whole was “reasonable and conservative”.

But the panel noted that it is impossible for an outside party to replicate the loss projections that form the core of the tests.

The stress test results on May 7 caused many investors to breathe a sigh of relief when regulators ordered 10 of the top 19 U.S. banks to raise nearly $75 billion in new capital, far less than feared. Since then, the tested banks as a group have executed or announced share sales totaling about $65 billion.

The report also comes as the Treasury on Tuesday granted permission to 10 banks to repay $68 billion in emergency government capital investments received last fall.

Warren said in her testimony that the statute governing the $700 billion financial bailout fund is “ambiguous at best” on the question of whether the Treasury can funnel repaid funds into new aid efforts. Some lawmakers, particularly Republicans, have said the money should be used to pay down U.S. debt.

However, Warren said she believes Treasury has grounds for interpreting the statute to mean it has authority to recycle the funds.

She added that the oversight panel, which includes a former senator and a current member of the House of Representatives, will review transactions in which banks repurchase stock warrants from the Treasury to ensure they are valued properly.

The valuation of warrants, meant to provide taxpayers some potential for gains from government capital injections, will be a key focus of the panel’s July report.

The oversight panel’s report acknowledged that the stress tests had a positive effect on market confidence, but it cautioned against assigning too much value to them.

“They do not model bank holding company performance under “worst case” scenarios, and as a result they do not project the capital necessary to prevent banks from being stressed to near the breaking point,” the panel said.