The Dodd-Frank Act mandates annual stress tests to reassure the market that the moral obligation to bailout the banks is still in place.
Each year, the Fed recognizes that the safety and soundness of the financial system requires that it say the banks are adequately capitalized. Naturally, the Fed sticks to this script even if the reality of the losses hidden on and off the bank balance sheet suggests otherwise.
By sticking to the script, the Fed obligates the US Treasury to bailout the banks should they encounter any solvency problems. This obligation occurs because it is hard to stick investors with solvency related losses after the Fed has effectively recommended the banks as an investment.
Regular readers know that FDR specifically pointed out that the role of government is to never make an investment recommendation as doing so creates a moral obligation to bailout the investor. Rather, it is the role of government to ensure that all the useful, relevant information is made available in an appropriate, timely manner. Investors have an incentive to use this information as they are responsible for all losses on their investments.
Naturally, under the Geithner Doctrine (nothing should be done that would hurt the profits or reputation of a big or politically connected bank), the US government adopted incurring the moral obligation. With this obligation, the government improves the profitability and reputation of the banks.
This year, the banks are turning their guns on making a mockery of bank capital regulations. Having gamed the system to show high levels of capital, the banks are set to engage in massive payouts to shareholders.
The six largest U.S. banks may return almost $41 billion to investors in the next 12 months, the most since 2007, as regulators conclude firms have amassed enough capital to withstand another economic shock.....The highlighted text nicely summarizes one of the most important failures in the response to the financial crisis.
Regulators are offering their opinion on whether the banks have enough capital or not to withstand another economic shock.
Please recall that these are the same regulators who missed the financial crisis.
Were it not for the moral obligation, actually it is more than that since then Treasury Secretary Tim Geithner pledged the full faith and credit of the US to supply the banks with all the capital they need, there would be no reason to bet on what is inside the black box banks.
However, with the downside eliminated by the US government, no reason not to gamble....
“You’ve gone from a few years ago, when the industry as a whole didn’t have enough capital, to the point where in the not- too-distant future, it’s going to have too much,” Jason Goldberg, a New York-based banking analyst at Barclays Plc, said in a telephone interview. The Fed’s endorsement is “a Good Housekeeping seal of approval.”A seal of approval that FDR would say should never under any circumstances be provided by the government as it creates the obligation for the government to absorb the investors' losses.