The Problem With Stress Tests
They do not, and perhaps never will, reflect the financial system’s ability to withstand a crisis.
How’s the foundation?
Photographer: Timothy A. Clary/AFP/Getty ImagesBack in 2009, in the darkest days of the global financial crisis, the U.S. government embarked on a high-stakes effort to restore confidence. Its primary tool: stress tests of the country’s largest banks. The Federal Reserve estimated how much the institutions stood to lose, and the Treasury promised to provide whatever resources they needed. The exercise worked surprisingly well, and proved to be the turning point for the recovery.
Since then, stress tests have become standard procedure around the world, but with a different mission. Instead of shoring up the system, they seek to ensure that banks can weather a future crisis. It’s a role for which they are less well suited, and that threatens to create a false sense of security.