Stress-testing

Last Wednesday, the Treasury Department released more details of its plan to stress-test America’s 19 largest banks to see just how short of capital they would be if the

recession worsened. Since many of the banks have been deemed too big to

fail, it is important for the government to know how much capital they may need to absorb losses and sustain lending.

The problem is that a bank is likely to convert the shares only if its condition continues to deteriorate, which would stick the taxpayer with stock falling in value. If the bank’s prospects are good and it pays back the government within two years, all of the stock’s future gains go to existing common shareholders. The system would be preserved, but by enriching private investors at taxpayers’ expense.

The Obama administration has never adequately explained why rescuing the weakest banks should involve rescuing their shareholders, and by extension, their executives and managers, whose wealth is likely to be concentrated in the stock of the bank. Instead, they have staked out a seemingly arbitrary position, insisting the government should not assume control of perilously weak big banks, even if only to restructure their finances. Before the stress test results are in, taxpayers deserve an explanation.