Even with these design features, the Fed’s stress-testing framework has some limitations in counteracting the inherent pro-cyclicality in the availability of credit. Indeed, the stress tests have become less binding on banks as the recovery has gathered strength. Thus, losses on loans and positions in the severely adverse scenario among participating banks have declined over time as the economy has strengthened.
But what we are getting instead are failures in the non-finance sector, Enron, WorldCom, etc., and more particularly a severe tightening of belts in the corporate sector with consequent contractionary effects on investment and employment.