The Big Bank Stress Tests came about in the Dodd-Frank bill in 2009. The idea was that systemically important banks had to have reserves enough to survive a recession.

Two weeks ago all 35 big banks passed the stress tests.

Or did they?

Deutsche Bank ended up failing the stress test, but investors simply ignored the results.



Goldman Sachs analysts said the U.S. Federal Reserve’s issues with Deutsche Bank were “long standing” and “not new”, while UBS said the failure was “not a total surprise.”

It was interesting that Goldman mocked Deutsche Bank, because behind the scenes Goldman Sachs was screaming bloody-murder.



On Thursday evening, after the release of the first stage of the annual bank stress test, Goldman Sachs Group Inc. put out a statement indicating that it was unhappy with the results and said that it planned to air its grievances with the Federal Reserve. The bank said its estimate of how much it would lose in an economic downturn “diverged” from the Fed. And it suggested that after a talk with the Fed, the regulators were sure to see things Goldman’s way. “The [Dodd-Frank Act Stress Test] ratios that are published today may not represent our firm’s actual capital return capacity, which may be higher than this year’s test would otherwise indicate,” Goldman said in a statement.

Now why would Goldman Sachs think that they could get the Federal Reserve regulators "to see things Goldman’s way"?

Maybe because the Fed isn't really a regulator at all. Instead, the Fed has completely betrayed it's role as bank regulator, and has become the Protector of Wall Street.



Federal Reserve officials told Goldman Sachs Group Inc. and Morgan Stanley that they were about to flunk a portion of the annual stress tests but offered them a deal to avoid an outright fail and continue paying billions to shareholders. In phone calls to executives of the Wall Street titans on June 21, regulators told them that to fully pass the test, they would have to cut almost in half the combined $16 billion they had hoped to pay out to shareholders, according to people familiar with conversations between the Fed and both banks. But Fed officials gave the banks an unprecedented option: If they agreed to freeze their payouts at recent levels, they would get a “conditional non-objection” grade and avoid the black eye of failure. That meant the banks could pay out a combined $13 billion, or about $5 billion more than what they would have given back to investors if they had decided to retake the test and get a passing grade. It also will boost a profitability measure that helps determine how much Goldman Chief Executive Lloyd Blankfein and Morgan Stanley CEO James Gorman are paid.

So when the choice came between a) give less money to shareholders, or b) change the rules to reward bad behavior and undermine the entire concept of the tests, the Fed chose "b".

“The Fed was very kind,” said Arthur Angulo, a managing director at Promontory Financial Group and a former Fed official. He added the Fed’s exercise of discretion on the quantitative portion of the test was “a potential slippery slope.”

I know that many people were angry about Congress gutting Dodd-Frank a few months ago, but the fact is that if the regulators aren't really regulators, then Dodd-Frank is a dead letter anyway.



“In the past, bank stress tests were real tests,” the Ohio senator said Tuesday afternoon. “These days, it is more like a cozy conversation between friends.”