Fed: Stress-Tested Banks Will Be Saved

The Federal Reserve on Friday said the government is prepared to rescue any of the banks that underwent "stress tests" and were deemed vulnerable if the recession worsened sharply.

The Fed, in outlining the tests' methodology, said the 19 companies that hold one-half of the loans in the U.S. banking system won't be allowed to fail - even if they fared poorly on the stress tests.

The Fed reinforced its view that major financial firms are "too big to fail," and the government must do whatever is necessary to save them, said former Fed examiner Mark Williams.

"It appears 'too big to fail' is a fundamental philosophy - it's a philosophical principle," said Williams, a finance professor at Boston University.

Critics say that policy has put taxpayer money at risk on behalf of banks that have received billions in government bailouts and guarantees.

Separately Friday, bank executives were being briefed on their test results in meetings across the country. By law, the banks cannot publicize the results without the government's permission, but Wall Street buzzed with anticipation and most financial stocks rose. The Dow Jones industrial average added 119 points to 8,076.

The Fed released the details of the test itself, which simulated how the banks would hold up in more severe conditions, reports CBS News correspondent Anthony Mason. The tests simulated the economy contracting more than 3 percent this year, unemployment hitting more than 10 percent next year and house prices falling 22 percent in 2009 and another 7 percent in 2010.

But some analysts say those assumptions may not be severe enough.

"When you look at their bad case scenario, it's now much more like what most people are expecting," economist Frederic Mishkin told Mason.

Wall Street is still skeptical. If the government gives the banks an A-OK, says bank analyst Dick Bove, no one will believe it. If it says the banks are in trouble, it could cause another panic.

"I think it's a public relations gimmick that went bad," Bove told Mason. "So they've put themselves into a corner. And it's really going to be interesting to figure out how they come out of it."

Fed officials said in a conference call with reporters that banks will be required to keep an extra capital buffer in case losses continue to mount.

The tests were designed to gauge how banks would fare during a much worse recession than most economists expect. But the Fed said that a bank needing more capital to cushion against loan losses under its "adverse" economic scenario should not be considered insolvent.

Rather, such a bank - if it could not raise additional money from private investors - could get financing from the Treasury's bailout fund.

Even if the tests showed a bank needs more capital, that "is not a measure of the current solvency or viability of the firm," the Fed said in a description of the tests' methodology.

Battling the worst financial crisis since the 1930s, the government has committed more than $11 trillion in loans, investments and other measures to prop up troubled institutions and stabilize the banking system.

For months, officials have put off questions about the banking system by saying they're awaiting the stress-test results.

The delays have led investors to fret: If the tests show every bank to be strong, they will look like a whitewash and won't be taken seriously. Yet once investors can distinguish stronger from weaker banks, they could start selling off weaker banks that remain stable but might falter if the recession got much worse.

The banks will have a few days to review the government's stress tests results and appeal any findings they disagree with. Regulators will give them the final results next Friday, according to two people familiar with the matter who spoke on condition of anonymity because they were not authorized to discuss it publicly.

In a conference call with journalists, senior Fed officials said regulators will be keeping a close eye on banks to make sure they have adequate capital to withstand likely losses on mortgages and other assets as the recession drags on.