June 9, 2009: TARP Congressional Oversight Panel Recommends that Congress Maintains Regulator Stress Tests and Increase Test Scenarios for Adverse Conditions

The Congressional Oversight Panel, charged with monitoring the $700 billion TARP, says that as long as banks keep large amounts of toxic assets on their books, regulators should conduct stress tests on them. Noting that the worst-case unemployment rate used in recent bank stress tests will soon be surpassed, panel chair and Harvard law professor Elizabeth Warren tells Congress’s Joint Economic Committee, “We have not actually broken through the worst-case scenario, but the numbers are bad and they’re heading in the wrong direction.” The Congressional Oversight Panel, which includes a former senator and a current member of the House of Representatives, also advocates replicate periodic tests as long as banks hold “appreciable amounts” of illiquid mortgage securities. Warren says the “US unemployment rate average for 2009, now at 8.5 percent, will soon exceed the 8.9 percent as the worst-case scenario used in regulators’ capital evaluations of the 19 largest US bank holding companies.” Unemployment climbed to 9.4 percent in May; many analysts expect the rate to increase. “The worst-case scenario number for 2009 is in fact not the worst case. We’re going to see worse numbers,” Warren affirms. Ordered for the top 19 US bank holding companies by the US Treasury Department, the panel’s monthly report says the stress tests used a risk-modeling approach that, in its totality, was “reasonable and conservative.” However, the panel also says that an external party would find it impossible to imitate the loss projections forming the core of the tests. Warren adds that to ensure they are valued properly, the oversight panel will also review transactions in which banks repurchase stock warrants from the Treasury. Valuation of warrants, intended to provide taxpayers a potential for gains from government capital injections, will be a key focus of the panel’s July report. While the panel’s report acknowledges that the stress tests had a positive effect on market confidence, it cautions against assigning too much value to them. “They do not model bank holding company performance under ‘worst case’ scenarios and, as a result, they do not project the capital necessary to prevent banks from being stressed to near the breaking point,” the panel says. Warren notes her oversight board was rebuffed although it “pressed really hard on the Fed” for more stress test details. She adds that the Treasury under Secretary Timothy Geithner has been more open. She also tells lawmakers that giving the panel subpoena power would make it easier to acquire documents and testimony from officials at Treasury and the Federal Reserve. [Reuters, 6/9/2009]