What Government Stress Tests Mean for the Stock Market

Ever since the Obama administration took office, the stock market has waited for the treasury to conclude its much talked about "bank stress tests." The tests are designed to determine which banks need more capital and thus which stocks are likely to sell off.

When a bank needs to raise capital, it usually mean existing shareholders will get diluted. The bank either has to get more money from selling stock (which makes the price go down) or by selling debt (which makes servicing old debt harder). That means the stock market is watching the outcome of these tests with baited breath.

Given the stock market's 20% bounce off the march bottom, some view this as a time to be cautious. If the bank stress tests turn out poorly, the market may be in for a correction. But the government has a vested interest in keeping the banks solvent. This is because the taxpayer has become the de facto shareholder through the market bailout plan. The administrations unwillingness to release the results may be an attempt to make sure everything looks as good as possible.