The Congressional Oversight Panel (COP) issued a press release today, announcing the publication of its June Oversight Report, “Stress Testing and Shoring Up Bank Capital.” The report examines the recent stress tests conducted by the Federal Reserve and other Federal banking agencies on the 19 largest bank holding companies. Professor Elizabeth Warren, Chair of the COP, also testified today at a Joint Economic Committee (JEC) hearing, “TARP Accountability and Oversight: Measuring the Strength of Financial Institutions,” providing the JEC with a summary of the report and responding to additional questions.

The COP report found that the stress test models utilized by the Federal banking agencies were reasonable and the results “were based on a solidly designed working model.” However, the report also identified several areas of concern with respect to the stress tests and the need for additional disclosures from the Federal Reserve on the stress tests to give third parties the ability to independently verify the results. An additional concern was raised regarding the relatively short time frame – through year-end 2010 – covered by the stress tests, noting that such a time frame “may fail to capture substantial risks further out on the horizon.” One such impending issue is “the projected rise in the defaults of commercial real estate loans after 2010” that was noted at the COP’s field hearing in New York City last month. Other issues identified in the report for consideration included:  

  • Since the unemployment rate climbed to 9.4% in May, bringing the average unemployment rate for 2009 to 8.5%, continued increases could result in the 2009 average exceeding the stress tests' assumed 8.9% level, suggesting that the stress tests should be repeated if that occurs.
  • Stress testing should also be repeated so long as banks continue to hold large amounts of toxic assets on their books.
  • Between formal tests conducted by the regulators, banks should be required to run internal stress tests and share the results with regulators.
  • Regulators should have the ability to use stress tests in the future when they believe that doing so would help to promote a healthy banking system.  

At the hearing, Congresswoman Carolyn Maloney, Chair of the JEC, noted that recent reports that Treasury will permit several financial institutions to repay TARP money raise additional concerns about the validity of the assumptions utilized by the stress test model. Professor Warren’s written testimony stated that an independent analysis of the stress test assumptions was based on available information and that “the Federal Reserve used a conservative and reasonable model to test the banks, and that the model provides helpful information about the possible risks faced by bank holding companies and a constructive way to address those risks.” However, she cautioned that the considerations listed above should continue to be in the minds of policy-makers going forward.

Separately, Representative Jeb Hensarling (R-TX), the lone sitting member of Congress on the Congressional Oversight Panel, introduced legislation (H.R. 2475) yesterday that would put “a firm end point in place for TARP – December 31, 2009.” Rep. Hensarling stated that “the economic justification for TARP’s creation and taxpayer assistance to financial institutions no longer exists,” and summarized the key provisions of the legislation as follows (the text of H.R. 2475 has not yet been received from the Government Printing Office):

  • Sets December 31, 2009 as a firm end date for TARP.
  • Banks that were stress tested can repay if they passed the stress test or complied with the requisite capital raises, consistent with the conditions set by the Treasury and Federal Reserve.
  • Any bank that attempts to repay and is rejected must be told in writing how the bank can repay successfully.
  • Guarantees well capitalized banks that have paid their TARP CPP dividends the right to repay the government.
  • After a bank fully repays the TARP monies they owe, the Secretary of the Treasury must liquidate any remaining warrants.
  • All preferred shares can be repurchased at the same price and private banks can repurchase the exercised warrant preferred shares at their pre-exercise price, if the private bank repays on or before September 30, 2009.
  • As banks repay TARP funds, the TARP spending authority is notched down accordingly dollar for dollar.