NEW YORK – The U.S.'s largest financial institutions have enough armor to withstand the turmoil of a major and prolonged U.S. and global recession, the Federal Reserve said Thursday.
The annual "stress tests" show that the 33 largest financial institutions, including JPMorgan Chase, Citigroup, Bank of America and Wells Fargo, all hold more capital than they did the year before. They also hold enough capital that, even if faced with billions of dollars in losses from loans as a result of an economic crisis, they would continue to function.
The stress tests were created in the wake of the financial crisis and subsequent Great Recession. The implosion of the housing market led the U.S. into its worse economic period since the Great Depression. Several large banks failed or were bought in to rescue operations. The losses were so great that U.S. taxpayers had to come to the rescue, at a cost of $700 billion.
This is the sixth round of stress tests the Fed has done, starting in 2009.
To keep this from happening again, Congress passed the Dodd-Frank financial reform laws in 2010. The law mandated the nation's largest banks simplify their structure, raise more capital, and that the nation's bank regulators had to routinely monitor and test to make sure banks could withstand even the worst possible outcomes.
Under the Fed's most extreme scenario in this year's test, the U.S. economy falls into a deep recession causing the stock market to plunge by 50 percent. Unemployment climbs above 10 percent, and housing prices drop by 25 percent and commercial real estate prices fall by 30 percent. Investors, in this scenario, would be so panicked that yields on short-term U.S. Treasuries would go negative — meaning even the safest of assets would still lose money.
Federal Reserve officials change the stress tests each year to mirror what economic climate the world is currently experiencing. Other central banks have attempted negative interest rates, including the European Central Bank and Bank of Japan, to stimulate economic growth. So testing the largest U.S. financial institutions under negative interest rates is not outside the realm of possibilities.
The Fed said that the nation's 33 largest banks would have $526 billion in loan losses under the most extreme scenario.
Thursday's announcement is one part of two announcements by the Fed regarding the stress tests. The more important announcement comes next week, when the Fed will release the results for each of the individual banks. If the banks pass, they will be allowed to raise their quarterly dividends and buy back shares.