Stress Test for Banks During the Foreclosure Crisis

President Barack Obama’s administration has released key details of its plan to evaluate the status of the country’s 19 largest banks during the downturn exacerbated by the foreclosure crisis. This evaluation will prepare the administration for another bailout of the financial industry if needed.

Among these major banks are Bank of America, JPMorgan Chase and Citigroup. These banks will be subjected to an assessment called by Obama’s economic planners as stress test. The test will estimate bank losses from 2009 to 2011 and the banks’ abilities to bear losses if the foreclosure crisis continues and the economy worsens.

Financial industry regulators, led by the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision, will assess the performance of bank assets such as securities, loans and collateralized debt obligations using two different economic scenarios. The scenarios would be based on present economic expectations and on a worse scenario in which the foreclosure problem worsens and housing prices decreased by another 20 percent over a two-year period and unemployment soars to more than 10 percent.

After the assessment, banks that need additional funds will be given 6 months to obtain funds from private investors. The federal government would intervene only if these banks fail to get additional funds. The government will buy preferred shares that would be turned into common stock over time, helping increase the banks’ capital.

One administration official said the assessment is one step to more carefully allocate the remaining $350 billion of the financial bailout funding approved by Congress in October 2008.

Donald Musso, founder of financial consulting firm FinPro, said the bank bailout in 2008 was not carefully planned. This time, he said, the Obama administration has learned from the 2008 experience. Any bank that would accept financial assistance from the government will be required to offer loans that will help solve the foreclosure crisis. In 2008 and early in 2009, lawmakers criticized the banks which received federal money for their failure to offer loans that would have helped slow down home foreclosures.

News of the bank assessment plan helped lift the share prices of major banks such as Citigroup, Bank of America, Wells Fargo and JPMorgan Chase. Despite the continued foreclosure problem, many bank stocks managed to make gains because of the administration’s foreclosure program and assurance from government officials that there are no current plans to take over the troubled financial giants.