Consider taking an exam without clear guidelines on what will be assessed. Many students have likely experienced this situation at least once, resonating with the frustration of preparing for an evaluation with unknown criteria. Now, imagine this teacher lacked the expertise to even grade such an exam effectively in the first place. This scenario illustrates the concerns of banking organizations suing the Federal Reserve over its ‘stress tests.’
Each year, the Federal Reserve implements a “stress test” on our nation’s banks to test their health in the event of extreme financial turmoil. Based on how the banks fare on the subjective and arbitrary grading criteria, the Federal Reserve then establishes capital buffers — essentially dictating to banks how much money they can lend and how much they must hold in reserves in case the Fed’s mysterious ‘doom scenario’ pans out. The problem, as identified in the recent lawsuit, is that this test contains “vacillating and unexplained requirements” that impose “billions of dollars in unexpected capital burdens on individual banks with no evident reason, and with adverse effects on the economy as a whole.”
While the Fed keeps much of its grading system opaque, the result determines how much money banks can lend out to facilitate personal loans, small business loans, mortgage loans, and all other manners of investment in our economy. It’s noteworthy that these additional capital requirements (which burden our economy) are not established by Congress but rather by unelected bureaucrats on the Federal Reserve Board. Which begs the question — what makes them qualified to even grade such a test?
Consider the Federal Reserve’s current financial situation. The Fed now owes the U.S. Treasury over $200 billion due to its banking activities. As the chart below shows, a significant drop in remittances emerged in 2022, coinciding with Jerome Powell’s chairmanship, which began in 2018. Under Powell’s regime, the Fed is essentially paying more interest on its liabilities than it earns on its assets, resulting in a net loss. Put simply, its loans are underperforming.

With the Fed now operating at significant losses it so recently incurred, it strikes one as strange that they would be entrusted to tell profitable banks when, where, and how much, they can lend. It seems a bit like asking MySpace how to run Facebook. And as the lawsuit notes, efforts from banks to opine on the criteria with which they are graded — as all sectors of the economy are legally afforded via the Administrative Procedure Act — have been substantively ignored. Taken together, the underperforming Fed is essentially freezing the assets of good banks without any due process.
The Fed had pledged to reform these stress tests before the filing of the lawsuit. Maybe they will, given it seems by their own admission the process has been a failure. But one hopes these reforms come sooner than later so that our banks can have the freedom to lend money the Fed is arbitrarily locking away.
If the Fed is as all-knowing as it mythologizes itself to be, it wouldn’t be $200 billion in the hole.