The financial crisis that gripped the world in late 2008 was, most of all, a crisis of confidence. What we knew about the condition of America’s biggest financial institutions was bad enough, but what we didn’t know was terrifying.
This is why the “stress tests” that financial regulators publicly performed on 19 of the country’s largest financial firms last year were so helpful. In some cases the news was good, in other cases not so good. But at least we knew which institutions were crippled by non-performing mortgages and stuffed with other securities and derivatives of questionable value. The information gave crucial credibility to regulators’ contention that a combination of private capital and funds from the Treasury’s Troubled Asset Relief Program (TARP) would be enough to get struggling banks through the downturn.
Now it is Europe’s turn to deal with a loss of confidence in its banking system, and the continent’s leaders are wisely following the American approach of treating the financial infection with a strong dose of sunlight.
European governments have announced plans to conduct stress tests on 25 major financial institutions and to release results sometime in July. Some naysayers in European governments, including Austrian Finance Minister Josef Proell, want to hide the messy details, and the exact implementation of the plan is likely to vary because of Europe’s fragmented country-by-country regulatory scheme. However, the general consensus is to share information with the public even though doing so might make certain banking systems (like Germany’s, for example) look weaker than they had been previously assumed to be.
Spain, for good reasons, has led the way in pushing the European Union to be open with its test results. Spain has suffered from speculation that it may be nearly as badly off as Greece, and Prime Minister Jose Luis Rodriguez Zapatero has pushed through budget cuts and labor reforms in an attempt to stem such worry. Zapatero declared that Spain would make its stress tests public even before the EU decided on the measure as a whole, saying “There's nothing better than transparency to demonstrate solvency, to give confidence and to leave all these unfounded rumors behind us.”
Germany and France both firmly supported going public with the stress test results despite, or perhaps because of, their positions as the countries with banking systems most exposed to the risk of a Spanish failure. The United Kingdom has been calling for public disclosure of the condition of European banks for some time now. The current uncertainty is forcing European governments to prove, in effect, that their banks can survive a crisis.
It is not something European governments are obliged to do by law, and it goes against all the instincts of their bank regulators, whose desire to avoid sparking a public panic is practically genetic. But the Europeans saw how getting the bad news out in the open helped restore confidence in America’s banks, and they hope to achieve the same result. If their tests are credible and strict enough, and their disclosure is detailed enough, chances are good that they will get the results they want.