Banks Seem More Stressed-Out Than Stress-Tested

Perhaps the bank “stress tests” should have included a prescription for Valium, for many banks seem more stressed-out than stress-tested. When the results of the bank stress tests were announced, the government proudly proclaimed that the banking system was sound, that banks would be able to handle whatever adversities the economy could dish out. The results also showed an expected baseline for unemployment and a worst case scenario, and Treasury Secretary, Geithner assured us that their calculations demonstrated that our banking system could withstand a worsening economy.

But the stress tests didn’t imagine that the economy might sink below their more adverse scenario. While it may have been difficult for them to envision employment levels sinking below those of recent recessions, that is the reality for the millions of jobless who have no prospect for employment. The stress tests’ worst case unemployment numbers have been exceeded in each of the first three quarters of this year; and today’s release of the numbers for August show that we’ve already reached their fourth quarter worst case projection.

According to the FDIC, 25% of our banks are currently unprofitable, suffering from mounting foreclosures, defaults from small business, and with a second wave of foreclosures looming on the horizon. Then, we have what some have described as the commercial real estate “landmine,” set to explode in 2010 with repercussions into the next year. With defaults including auto dealerships, hotels, malls, and retailers, our banks seem more stressed-out than stress-tested.

The government’s problem bank list has exploded in just over a year. In June of 2008 the list included slightly more than 100 banks, a number that had tripled by March, and that has now grown to more than 400. Some experts have predicted that there may be as many as 500 additional bank failures; half that many would be a disaster that would impact regional banks especially hard. While the government has demonstrated that big banks—with big lobbying budgets and friends in high place—will not be allowed to fail, the smaller regional banks pose a prime target with their balance sheets overflowing with defaulting construction, development, and commercial real estate loans.

The failure of several hundred community banks will wipe out the FDIC deposit insurance fund, and while the government, with taxpayer support, is providing loans to cover the shortfall, the amount only adds to the deficit. Worse, multiple bank failures will be a heavy blow to local business who depend upon “relationship banking” for loans and lines of credit. The “stress” from the banks, like a virus, may continue to infect the economy.

The Housing Guru: The one source for all your housing questions