WASHINGTON — The Federal Reserve on Friday said the government is prepared to rescue any of the banks that underwent "stress tests" and were deemed vulnerable if the recession worsened sharply.
The Fed, in outlining the tests' methodology, said the 19 companies that hold one-half of the loans in the U.S. banking system won't be allowed to fail — even if they fared poorly on the stress tests.
The Fed reinforced its view that major financial firms are "too big to fail," and the government must do whatever is necessary to save them, said former Fed examiner Mark Williams.
"It appears 'too big to fail' is a fundamental philosophy — it's a philosophical principle," said Williams, a finance professor at Boston University.
Critics say that policy has put taxpayer money at risk on behalf of banks that have received billions in government bailouts and guarantees.
Separately Friday, bank executives were being briefed on their test results in meetings across the country. By law, the banks cannot publicize the results without the government's permission, but Wall Street buzzed with anticipation and most financial stocks rose. The Dow Jones industrial average added more than 119 points to 8,076.29.
The Fed release contained little new or concrete information. But Fed officials said in a conference call with reporters that banks will be required to keep an extra capital buffer in case losses continue to mount.
The tests were designed to gauge how banks would fare during a much worse recession than most economists expect. But the Fed said that a bank needing more capital to cushion against loan losses under its "adverse" economic scenario should not be considered insolvent.
Rather, such a bank — if it could not raise additional money from private investors — could get financing from the Treasury's bailout fund.
Even if the tests showed a bank needs more capital, that "is not a measure of the current solvency or viability of the firm," the Fed said in a description of the tests' methodology.
The banks will have a few days to review the government's stress tests results and appeal any findings they disagree with.