Would your bank pass the Treasury’s new ‘stress test’?

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The Obama administration plans to create a ‘stress test’ for big banks as part of the new financial-system rescue plan.

That might have contributed today to the vicious sell-off in financial shares, which once again led the stock market lower. Some investors may have had visions of their bank keeling over during the stress test, much like a terribly out-of-shape person collapsing on a treadmill.

An index of 24 major bank stocks dived nearly 14% today, although it held above its lows of last week. Bank of America Corp. slumped 19% to $5.56, Wells Fargo & Co. tumbled 14% to $16.35 and Citigroup plunged 15% to $3.35.

The Treasury’s fact sheet on the new rescue plan describes the planned stress test as ‘an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected.’

All banks with assets exceeding $100 billion will be subjected to the test.

What happens if a bank fails the stress test? In a briefing for the press after Treasury Secretary Timothy Geithner‘s speech, officials suggested that the test wouldn’t be ‘pass or fail,’ but a question of what level of capital was adequate. The Treasury fact sheet said that a bank that has undergone a stress test ‘will have access to a Treasury-provided capital buffer to help absorb losses and serve as a bridge to receiving increased private capital.’

But that raises the specter of greater government ownership of the big banks -- creeping nationalization -- if they are basically forced to take more taxpayer capital to bolster their balance sheets against further loan losses.

‘People think ‘nationalization,’ and that scared them’ on Wall Street, said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York.

Just in the last two weeks, banking giants including Bank of America and Wells Fargo have assured shareholders that they had no plans to ask for additional government funds.

Now they might have to add, ‘. . . assuming we pass the stress test.’

-- Tom Petruno