Federal Reserve Board Governor Daniel Tarullo. Federal Reserve Gov. Daniel Tarullo said something earlier this week that should cause the ears of every adult in the country to prick up: While America's big banks are in better overall shape than they were just before the start of the 2008 financial crisis, there's still "room for improvement at virtually every firm."

Considering how quickly the big banks started to circle the drain after Lehman Brothers filed for bankruptcy in September 2008, saying the banks are in better shape today than they were then isn't saying much at all.

This announcement by a Fed governor, then, is damning with faint praise at best, and more like a barely disguised warning about the state of the U.S. banking system.

How Banks Fared in Worst-Case-Scenario Tests

Tarullo is the Federal Reserve governor who ran the country's biggest banks through their most recent set of "stress tests." These stress tests were designed to see how the banks would respond to a simulated, worst-case economic scenario -- a 50% decline in the stock market, a spike to 13% unemployment, an 8% drop in gross domestic product, low interest rates, and a European market crisis.

Nineteen banks were tested, all of the "too big to fail" variety. They included Goldman Sachs (GS), Morgan Stanley (MS), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C). Four failed, with the remainder passing to one degree or another: some coming through strong and others just squeaking by.

Citigroup, to everyone's surprise, failed. For shareholders, that meant the bank couldn't raise its dividend or buy back any shares, two things that make shareholders very happy and boost share prices -- something that makes the banks very happy.

It's an Economically Terrifying Life

When Tarullo said there's "room for improvement at virtually every firm," he was referring specifically to the way in which the banks were managing their capital. And there's the rub. Because if a bank is about nothing else, it's about capital -- how much it has overall, what it does with it, and how much of it can be quickly gotten when the situation suddenly goes south, like it did in the fall of 2008.

Lehman Brothers had too much debt, had too little capital, and was therefore overly dependent on a system of bank-to-bank overnight lending to remain solvent.

Once word got out that Lehman was in trouble, other banks stopped lending to it. Once that happened, it quickly descended into bankruptcy, starting a chain of events that nearly brought all the rest of the big banks with it.

It was a classic bank run, right out of It's a Wonderful Life, except this time with global economic repercussions.

The Financial Crisis: It's Not Dead Yet

Banks need to have capital on hand, for situations foreseen but mainly for situations unforeseen. And as we all quickly found out, the banking system lies at the very heart of our day-to-day economic existence. When the banks aren't working, nothing's working. Businesses can't get loans, which means they can't buy the equipment they need to stay in business or make payroll. It also means consumers can't get loans, which means they can't buy cars or refrigerators or houses -- the making of which keeps people employed. It's a vicious cycle.

So this is what the stress tests were all about -- sorting out which banks were strong and which still needed help. And that's why, when one of the Federal Reserve's governors says that the banks have shown some significant weaknesses, even after what were supposed to be the most rigorous of stress tests -- we all need to sit up and take notice.

News of the death of the financial crisis has been greatly exaggerated. The recently completed stress tests should really be looked at as a kind of parole, with the idea that the banks will be kept under strict supervision until they prove that they can move freely among the economic populace again without doing themselves, and therefore the rest of us, any harm.

Motley Fool contributor John Grgurich owns no shares of any of the companies mentioned in this article.




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Wayne Bradshaw

Gucci sent their fall/winter 2012/2013 collection down the Milan Fashion Week runway today and it featured a much darker, more gothic and vampire-like color palette than what was shown by the iconic design house for fall 2011. One year ago Gucci Outlet showed bright colors and blocked them together, helping to explode the current color blocking trend. For fall 2012, Gucci moved away from the trend they started and let black rule the runway.

May 06 2012 at 12:05 AM Report abuse rate up rate down Reply
bill

Face it......this is all a product of the 70's down with the establishment protests. These are the people that were protesting instead of hitting the books. They didn't want to work then and they don't want to work now.....just have us pay for their lavish lifestyles. Just take a look at the GSA and their lavish party.

April 17 2012 at 8:17 AM Report abuse +1 rate up rate down Reply
bobbsafe

Very few working Americans are creating ANY tangible assets anymore, while money is being printed like crazy. The Bush years saw reckless spending in Iraq, with unregulated loans to unqualified borrowers, including credit cards issued freely. The Fed cannot "spend" its way out of this and the jobs have not come back yet. (They are in maintenance as everything is already built) Obama has been spending like crazy also to try to create M1 but the damage has been done. Hey - I voted for Gore.

April 17 2012 at 8:13 AM Report abuse -1 rate up rate down Reply
wwwarrington

CAPITAL ONE PAYS .0025% INTEREST AND THEN PLAGUES ME TO TAKE OUT A LOAN FOR .075%????

April 17 2012 at 6:42 AM Report abuse rate up rate down Reply
A.G. SESKIS

P.S.
Also what about all the crooked loans the Banks gave out ,..knowing the risk,...without proof of income / etc. etc.
No down payments / no proof of crap ,...but a " word ".
Not only for private ,...but Big Public Comapnies / Insurance / etc.
All paper Bs ,..with no proof ,...and ** poof ** ,..look what happened in `08,...it finally caught up to the clowns.
Look who paid for it ,....... US,...with millions of jobs / etc. etc. And still a crappy economy in 2012 ,...hmmm.
Was the " Big Bailout of the Century " worth it ??? ......NO ,....not to save the crooked rich from their crooked investments,...while making millions suffer from it,..no way ,...not even from a comon sense point of view !!!
Just shows our own Govt. doesnt care about the PEOPLE. Look what the scandal / bail out cost us.
$ 14 Trillion in debt ,..and counting,...and no clue how to pay for it.
Just wondering ,.....Can I get a $14 Trillion loan ?????????,.....if not ,..why ????....I DONT have to borrow money every month to pay MY bills, ...so why is our GOVT, allowed to ?? What example is that setting to Americans ,...let alone the rest of the World ?
So ,...doesnt anyone else see a problen here ??
This crap started WAY before Obama hit office ,....try like 70 yrs ago. or better ,.....sad ,...our Country doesnt need to balance the budget ,.....BUT ,..We the People need to ,..or OUR CREDIT RATING IS SCREWED !! Or cant get a loan / borrow / etc/ etc. So why is our Govt. even allowed to borrow being $14 Trillion in debt ?? What principles are the Govt. any different from the avg. American ? DEEP in debt ,..unable to borrow / bad credit rating,..but yet our Govt. being $14 Trillion in debt can keep borrowing EVERY month just to pay the monthly bills ??? Why is this acceptable ?? Why is the Avg. Amercian held to a higher standard than our own GOVT. ?
Still dont see a problem ???
The financial wizards of DC get paid pretty well ,..why is our " Countries Checkbook " unbalanced ,..when we are forced to have "OURS " balanced ,..or we get penalized in more ways than one ??
TOTALLY SICK AND SAD !!
Thanks for reading.

April 17 2012 at 6:32 AM Report abuse +1 rate up rate down Reply
A.G. SESKIS

No kidding,
With higher " fees "/ etc. /etc. sure they are posting profits NOW.
Of course, we only " pacified " the problem back in `08.
And why did we even " bail " them out to begin with ??
The "super-smart " bank clowns knew what they were doing, knew the risks, they did it anyway ,...and got help from the " CRONIES " IN D.C. !!
How sick is that ??? And they still are doing the same thing TODAY ,..just hiding it better is all ,....the clowns have learned NOTHING !!!
And We the People keep paying for it ,..how sad !!
Time for Americans ,..to wake up !! Withdraw from major Banks !! ....Go Credit Unions !!! No fees for checking / atm / debit , and LOW interest on credit cards !! Quit funding cronie clowns, and their lifestyle, while millions suffer the outragous fees / etc. !!
Withdraw from the BANKS ,...deposit to Credit Unions ,...STILL FEDERALLY INSURED !!! Just at NO cost to YOU !!!!!!!
Been a Credit Union Member for 25 yrs !! ..never a doubt, and kept MY MONEY ,..to myself !! ...Not to pay for rediculous " maintanance fees " the banks charge you, ..JUST to hold on to YOUR MONEY !!!
It`s all computerized ,....costs them nothing !! ...But the Banks charge you for your own money !!!
It`s wrong !! And they are profiting from YOUR money ,..not you !!
If everyone took their money out of the BANKS ,..then what are they going to do ?? CHARGE YOU ??, ...FOR NOT HAVING AN ACCOUNT ????????? CMON ....THEY ARE CROOKS PLAIN AND SIMPLE !!!
Thanks for reading.

April 17 2012 at 5:58 AM Report abuse +2 rate up rate down Reply
birthermajority

Yup, banks need to borrow MORE money at .1% from Fed and relend it to Treas at 2.22% to suck the life out of consumer/taxpayers and improve bank capital and performance bonuses to managers the stockholders who pay bankers to bribe Congress.

April 17 2012 at 5:46 AM Report abuse +1 rate up rate down Reply
ha6ai

This was a Democrat-created housing bust, and since then a Democrat disaster and an Obama disaster. The Dems forced and pressured the banks to loan to obviously unqualified borrowers and forced Fannie and Freddie to buy and back most loans. It came back to haunt tax payers (primarily the 50% who pay taxes). Since then Obama has created more wasted debt ($6 Trillion) - more debt than ALL the total debt created by ALL the presidents in American history - all in just 3 years! What a disaster.

April 17 2012 at 5:24 AM Report abuse +2 rate up rate down Reply
freeetob

"Foreclosure Phil" Gramm jammed deregulation of financial institutions as a last minute amendment to the 1999 budget. That can be repealed. Break up the banks that are "too big to fail" so they can never fail again. Banks and insurance companies have no business operating brokerages. The International Banking Mafia operates like one big casino betting clients' monies. Break them up!

April 17 2012 at 4:12 AM Report abuse +1 rate up rate down Reply
alexandra_garza

let the banks go down. its there own fault anyways

April 17 2012 at 3:59 AM Report abuse +1 rate up rate down Reply