Bank Stress Tests Could 'Harm Economy': Bove

NEW YORK ( TheStreet) -- The Federal Reserve's third-round of bank stress tests conflict with the central bank's "actions in attempting to stimulate economic growth," according to Rochdale Securities analyst Richard Bove.

Under the Fed's final ruling on its 2012 stress tests published Tuesday, the original group of 19 large U.S. bank holding companies that were subjected to two previous rounds of tests -- including the "big four" of JPMorgan Chase ( JPM), Bank of America ( BAC), Citigroup ( C) and Wells Fargo ( WFC), as well as U.S. Bancorp ( USB), PNC ( PNC), Goldman Sachs ( GS), Morgan Stanley ( MS), and 11 other companies -- will be joined by 12 more bank holding companies with over $50 billion in total assets, including Huntington Bancshares ( HBAN), Discover Financial Services ( DFS) Northern Trust ( NTRS), M&T Bank ( MTB), Comerica ( CMA), and Zions Bancorporation ( ZION).

The 31 bank holding companies subjected to the third round of stress tests are required to submit their 2012 capital plans by January 9, and will have their plans approved or rejected by the Federal Reserve by March 15.

The 2012 tests feature a severe set of economic assumptions for the maximum stress the banks need to be able to survive, while maintaining strong capital ratios and their capacity to lend, including A 4% decline in the U.S. gross domestic product, 13% unemployment, a 21% decline in home prices, and a whopping 52% decline in equity prices.

Bove said that the Fed's test parameters "are directly contrary to its actions in attempting to stimulate economic growth," and "the conflict is so severe that it raises the question as to whether the Federal Reserve understands the impact of bank regulation on monetary policy."

The point is that while attempting to stimulate the economy by growing the money supply, the Fed -- while putting on its bank regulatory hat -- forces the banks to hold so much extra capital for a rainy day, that the new money pumped into the economy won't be lent out to business that could expand and hire workers, but instead will be deposited with the Fed itself.

To illustrate this point, Bove points out that the Federal Reserve's total assets increased by 218% from Sept. 2007 to Sept 2011, while banks insured by the Federal Deposit Insurance Corp. saw their combined balances sheets expand by nearly 9%, their cash expand by 173%, and their equity increase by 19%, while loan balances declined nearly 5%.

This indicates a repeat of the scenario seen in the period of 1934 to 1945, according to Bove, when banks went from a ratio of cash plus securities to loans of roughly 2 to 1 in 1934, to a ratio of 5 to 1 in 1945.

Bove said "the government can make banks depression resistant," but that "the result in doing so is that the banks hoard funds, become risk averse, and the economy does not grow."

In its actions to counter the current credit crisis, Bove said the Fed's monetary easing "had no virtually impact on real growth and less than no growth on bank lending."

In summary, Bove said that "as the Federal Reserve pursued monetary and interest rate policies deemed to increase economic activity with the right hand; it took this money away from the economy by demanding more stringent banking operations with the left hand. It pursued policies that had diametrically opposing results."

Tom Brown -- the founder of Second Curve Capital, a hedge fund that invests in financial services companies -- earlier this week on BankStocks.com called the stress tests "an incredibly stupid, truly nonsensical practice" that defeats the purpose of bank regulators' capital ratio requirements for banks.

Brown said that "if regulators don't think the minimum standards they've set are sufficient for banks to see them through," rough economic patches, the regulators "can and should raise the standards," which would be a whole lot more simple than running annual tests with based on different economic assumptions.

Of course, the stress tests are required by the Dodd Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama in July of last year. But Brown said that if the government believes that "future credit downturns are apt to be more severe than past ones," the response should be to "dial up the minimum amount of capital cushion that banks have to hold," rather than change the playing field repeatedly "in a new round of annual stress tests for the banks."

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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