Stress Tests: Raising Capital at Citi, BofA, et al. the New-Fashioned Way

Have you ever had a real stress test? You get wired with electrodes that monitor your heart, and then start moving on a treadmill to see how much you can stand. Hopefully, you make it (there's a doc in the room in case you have trouble). Stress tests are a standard diagnostic device to assess our cardiovascular health.

Stress tests from the Treasury, however, seem to be of a somewhat different ilk. Yes, there is a test of your financial health, and there are doctors in the room (mostly Ph.D.s in economics from Harvard). But that's where the similarity ends. While a clean bill of (physical) health lets you live longer, stress tests that demonstrate you are in trouble only lead to more money from the government.

Treasury stress tests will require failing banks to raise money, but where is this going to come from? Independent investors are not exactly rushing in. Banks will need to sell assets to raise capital, but there are only so many Japanese businesses for Citi to sell before they come up against those toxic assets that nobody wants. So that leaves the federal government. For banks that are already in hock to the government, there's not much more downside to taking a little more cash. So, we have the topsy-turvy world of modern finance. Banks are better off if they fail their stress tests than if they don't! You fail the stress test on your heart, you die. You fail the bank stress test on your finances, you get to live longer.

Perhaps a slight exaggeration, but perhaps not.