Today at TILE… Stress Tests

February 25th, 2009

Today at TILE Financial, we talked about the US Government’s announced details on the Stress Test that banks will need to undergo. The results of the Stress Test will provide an indication of the financial well being of the bank and the need for added Capital (aka money) to make it healthy.

New York Times: Government Offers Details of Bank Stress Test

In essence the stress test is like a medical exam. If the doctor says you are deficient in Vitamin X, you then need to take special supplements to bring you back to a “good range”.

The Stress Test tries to illustrate what the Bank’s balance sheet will look like in a hypothetical/ worst case scenario (Some aren’t sure if that scenario is tough enough and others say it is too stringent). Assumptions include:

- the economy shrinks by 3.3% in 2009 and doesn’t grow in 2010

- housing prices fall by 22% in 2009

- unemployment rate grows to 10.3% by 2010

After carrying out the analysis, banks will either need to “Raise Capital” (aka money) themselves or go to the government for a capital injection (aka shot of money). In exchange, if using tax payer dollars, the US government would get an ownership share in the company.

The goal is to give people confidence that the banks have enough “money in the bank”/equity on the balance sheet to be healthy in tough times. Using the medical example, you want to make sure you take extra vitamins if you know you are going to be facing a stressful situation (e.g. maybe you try to get more sleep or eat better during final exams?).

For the TILE community, this has two implications. First, you may want to see how your financial institution did on the Government’s stress test. Does the test suggest the bank is healthy or at risk. If it needs more capital, how much is it receiving from the government? Some people are concerned that if the government owns too much of a bank, the bank will be less able to compete when the markets get better.

Second, watch the total amount of money the government “invests” in financial institutions. Right now they have already used $350 billion of the $700 billion rescue package. The more they use, the more they are creating a deficit (the governement owes more than it can pay) – and a future burden for future taxpayers (That is you!). If it can’t be paid back by normal means, your tax rate may increase. In essence the government is spending your future money to make the banks healthy today.

The TILE Community, more than anyone, has a stake in what is being done today – because you will be the large taxpayers in the future.

- Amy

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