There is a subtlety to the Obama administration's TARP principles that needs to be made explicit.


It's an arguable point, but these so-called stress tests, which will be involuntarily given to major financial institutions, are the spark plugs for a much larger government intervention in the banking system.

My premise is that policy and politics intersect. TARP II will not be administrated in a frictionless universe.

The major question for Treasury these days is: is the problem one of liquidity or insolvency? The administration's private answer: we know that it's an insolvency problem; we'll deal with liquidity in the near term and set up a way to deal with solvency over the long-term.


The point here is that the administration CANNOT force broad nationalization down Congress's throats; they CAN begin to make that argument when there is proof that a major bank is insolvent.


How does the administration prove this? 

By giving these banks physicals -- stress tests.


When it turns out that one, two, or four major banks or institutions are unquestionably on the brink of insolvency, it will be MUCH easier for the government to step in and seize them, politically and administratively.  Whether this is done by some new entity, a la Sweden, or by an existing entity, like the FDIC, is unclear, probably will depend on conditions at the time.

The government has neither the capacity or capability to see all the banks. And I'd bet that many physical might simply be given some medicine -- beta blockers, if you will -- in the form of cash to keep them minimally solvent until the crisis has passed. 

But others might be deemed too big too fail, and TARP II allows the government to take them over if necessary.