At what point will the government step in and take control of failing banks? That’s a question that a lot of Americans have been wondering about lately, and all we’ve known up to this point is that President Obama has made reference to a “stress test” that will be the determining factor.

Now the wait is over. The Treasury has revealed what the “stress test” will entail.

Their eyes are on you

David Ellis of CNNMoney.com reports that Obama’s plan to monitor and judge the health of America’s 19 largest banks was hinted at when the White House introduced its financial recovery plan. Designated banking regulators will watch banks like Citigroup, Bank of America and JPMorgan Chase and “estimate firmwide losses for the next two years if economic conditions worsened and the bank’s ability to absorb such losses.”

The Office of Thrift Supervision and the FDIC specifically will address asset performance – which shall include loans and securities like collateralized debt obligations – and judge it under two scenarios. The first would look at consensus economic expectations, while the second would assume a worst case scenario where unemployment went above 10 percent and home prices went down another 20 percent over the following two years.

Do-it-yourself first

Depending upon how the banks rank in these scenarios, the government will know which ones need the most help and perhaps additional stimulus. However, if it is determined that a bank needs help, they are first given six months to find private backing. If that fails, then the government will step in and buy convertible preferred shares. In time, the banks would have to convert that into common stock, which would boost capital to the necessary degree.

To avoid investor panic, the government said they won’t reveal the names of banks that require extra help, but how will they honestly be able to hide it? If they look for public funds, the cat’s out of the bag…

The money will be there… but only if they LEND

If banks are going to receive more funds, they’re going to have to increase lending. Credit must flow. After too many banks hoarded TARP money, it’s clear that this must be rigidly enforced before bank executives put their mark on the funds. Not changing their outlandish spending habits didn’t go over well with the public, either.

Good news! News of the stress test caused share prices to go up at Bank of America, JPMorgan Chase and Wells Fargo. Only Citibank went the other way. All of this is good news in the minds of investors, however, who fear complete government takeover. That could be on its way, despite President Obama’s denials…