Ben S. Bernanke, chairman of the US Federal Reserve, speaks to the House Financial Services Committee in Washington, D.C. on Wednesday.

The Obama administration’s much-anticipated stress test for the nation’s wounded banks may not live up to its name.

By analyzing the health of the 19 largest US banks, including Citigroup Inc., the recipient of US$45 billion of federal money, regulators assume that the economy will shrink as much as 3.3 percent this year, followed by growth of 0.5 percent in 2010, and that unemployment will rise as high as 8.9 percent and 10.3 percent, respectively. That may not be pessimistic enough to truly test the banks, analysts and economists said.

Rather than checking the ability of banks to withstand losses, the tests outlined Wednesday are designed to convince investors that the firms do not need to be nationalized, said analysts including Bush and Richard Bove from Rochdale Securities. The 24-company KBW Bank Index has plunged 43 percent this year on concern the government may have to take over some of the largest financial firms, wiping out shareholders.

“I have always thought that this stress-testing was a politically motivated approach to try to defuse the argument that the banks did not have enough capital,” said Bove, in an interview from Lutz, Florida. “They are trying to prove that the banks are well-funded.”

Worst-case scenarios

Citigroup may be first in line for an infusion. The Associated Press reported Thursday the federal government could raise its stake in the troubled bank this week to as much as 40 percent. The newswire cited unidentified people familiar with the matter. Citigroup spokesmen have declined to comment on more potential help from the government.

The government’s plans do not include nationalization, Federal Deposit Insurance Corp. Chairman Sheila Bair said on Wednesday night.

“That is not the route we are pursuing now,” Bair told reporters on Wednesday night after speaking at a dinner in New York, echoing remarks made earlier this week by Federal Reserve Chairman Ben S. Bernanke. “I think the markets need to calm down.”

Six weeks

The most adverse jobless numbers in the government projections are in line with the most pessimistic analysts in surveys of economists conducted by Bloomberg. The Treasury is giving itself six weeks to complete the assessment.

The rise in unemployment and drop in housing prices could be more dramatic than the worst-case expectations of the government, said Barry Eichengreen, professor of economics and political science at the University of California at Berkeley.

“My hope had been that when they did a real stress test it would be the equivalent of turning up the treadmill beyond a trot,” Eichengreen said in an interview. “There are now lots of people who accept the possibility that unemployment in 2010 could be in double digits. If we are serious about doing a stress test we should be looking at 11 percent rather than 10 percent.”

President Barack Obama’s administration is likely to seek more funds from Congress to buttress the Treasury’s $700 billion financial-bailout fund. The cash may be needed for more capital injections and for financing new efforts to thaw credit markets.

‘Baseline scenario’

The Treasury said it has until the end of April to identify how much extra capital is needed to protect banks with more than $100 billion in assets from losses on loans, securities and off-balance sheet commitments.

Regulators will test how well the banks can hold up in a “baseline scenario” with a 2 percent slide in the economy this year and unemployment at 8.4 percent, in addition to a “more adverse” situation. The test also assumes housing-price declines of 14 percent this year and 4 percent in 2010 as a baseline case. The more adverse possibility would see drops of 22 percent and 7 percent, respectively.

Following the test, lenders will have six months to raise private capital or accept government funds in the form of convertible preferred securities, which would acquire voting rights if converted to stock. The Treasury has used about half the $700 billion allocated by Congress for rescuing the banking industry, and most of that was spent under former President George W. Bush.

Last month, Bush’s successor inherited an unemployment rate of 7.6 percent, the highest in 17 years, and an economy that shrank 3.8 percent in the fourth quarter, the most since 1982. Economists, on average, expect unemployment to reach 8.8 percent by the end of this year, with the economy contracting 2 percent in 2009, according to Bloomberg surveys.

Given the surge in unemployment, the government is not testing for “an absolutely worst-case scenario,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York, who used to work at the Federal Reserve.

Source: Bloomberg