Over the last week two distinct stories about the bank “stress tests” have surfaced.  First, the Treasury was going to delay the release of stress test information until after earning season as to not cause any panic on Wall Street. The second, the Treasury allegedly told the banks that underwent the stress test to not release any information regarding the test results.

Travel back to 2002 with me, a time when the public was enraged with the scandals of Enron and WorldCom.  The public demanded accountability of financial information (well, politicians did – the public was more pissed that their retirement savings were wiped out) that was coming out of publicly traded companies.  

Enter the Sarbanes-Oxley Act (SOX).

Once instituted, SOX mandated a number of controls public companies had adhere to when reporting financial information.  One such control was “enhanced financial disclosures” which focused on internal controls that would assure that financial reports and disclosures were accurate.  The Act also called for timely reporting of material changes in corporate financial data.

You see the problem here?

If the financial stress test shows the financial data currently reported by the banks to be incorrect, and the bank management is aware the results of the stress test conflict with their own internal data, the banks are legally required to report the discrepancies.

The Treasury is, essentially, telling banks to ignore the law.

What happened to transparency in government and corporate financials?  How can one department of the government tell public companies to ignore federal law?  Better yet, why is no one calling attention to this?

The controls enacted in SOX were intended to provide transparency and accountability within publicly traded organizations, yet here the government is telling publicly traded companies to ignore transparency.

Something does not add up.

If you think back several weeks with me, you’ll remember the the Treasury announcing a “bank stress test” that would help determine what banks had enough liquidity to stay functional.  Former Bank regulator, William Black, believes it’s a sham in order to make the public believe the government is taking action:

There are no real stress tests going on. 

If you did a real stress test, as Geithner explained them, you wouldn’t just have a $2 trillion hole — you’d impose regulatory capital requirements of 50%…

You can’t conduct a meaningful stress test without reviewing (sampling) the underlying loan files and it seems likely that the purchasers of securitized instruments (not just mortgages) do not even have the loan file data…

As Geithner describes the process, NO ONE can conduct reliable “stress testing.” It inherently requires testing everything in every way any and all aspects of everything could conceivably interact. It also doesn’t provide any meaningful output that can be operationalized (unless you want to force an enormous rise in minimum regulatory capital requirements, which he obviously doesn’t want to do).

A number of other economists also question the point of the stress test.  The general feeling was that the “worst case” economic scenarios that were used in the stress test did not even come close to recreating the conditions the financial industry really will be facing.

If, indeed, the stress test was a sham AND the economic scenarios used during the test do not reflect reality, what does it mean that the U.S. Government is going to delay the stress test results until AFTER the earnings season that just started in order to prevent a market panic.

To me, this really means three things:

1. Even under the easy standards set in the stress test some financial institutions cannot pass the test
    
2. The government is looking to buy time in order to develop a plan for the banks that are insolvent
    
3. If the plan for insolvent banks is nationalization, the Treasury Secretary expects the stock market to react in a highly negative manner.
    

With the Alcoa news this week, the Fed Meeting Minutes showing the recovery will be longer off than expected and the release of TARP funds to Life Insurance companies today, what does it mean to hear the Treasury is planning on delaying the bank test results?  

Easy.  The worst of the worst is not even upon the financial market as of yet….