Why is it so few want to discuss the real reason for the Obama Administrations stress tests? It is only in part to bring greater “clarity” to the banking system—for the administration’s stated goal of restoring confidence. It seems blindingly obvious that the underlying reason for the stress tests is to downsize the largest banks so they are no longer ‘too big to fail’.

The largest banks are not undercapitalized. The Tier 1 capital ratios of Bank of America and Citigroup are 10.6 and 11.9 respectively, two to three times the minimum Basel I requirement of 4 percent. So it is in fact because the largest banks have become too big to fail, and so to big to regulate, that they are being forced to downsize.

Veteran Rochdale Securities banking analyst Richard Bove has repeated in various interviews—CNBC and CBS Marketwatch are two such—that the banking system has already been restored to health, both in terms of adequate capital and cash flow. Since last fall, at least $100 billion per month has been flowing into the banking system as consumers have saved more than they spent and investors seek safe havens. Some $2.5 trillion has been socked away in treasury debt and/or insured money market accounts, analysts estimate, waiting for the markets to turn.

On top of that, 97 percent of the $8 trillion in total loans on banks’ books were fully performing as of December 2008, the last reporting period for which there are accurate statistics, according to Mr. Bove. That means only a small percentage of their securitized assets are in fact toxic, contrary to the conventional wisdom.

A recent New York Times’ front page article on consumers’ shift from spending to saving that has brought the overall personal savings rate to 4 percent from zero in recent years is a major reason for banks’ regained health, as are the record low interest rates engineered by the Federal Reserve and Treasury.

So it is obvious why Bank of America and Wells Fargo are being targeted for such large capital injections, even though both reported record profits in Q1. They have been given a choice, since the amounts of additional capital required of them by the stress tests exceeds the amounts that can be raised in private capital markets. They must either divest themselves of some of their businesses, or the federal government will in effect nationalize them by converting its preferred stock shares to common voting shares.

This makes government the largest shareholders, putting them in position to sell off some of their assets as it has been doing with AIG and Citigroup, in order that they can return to the core business of banking for which they were chartered.

Harlan Green © 2009