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Wells Fargo should have failed the stress test

March 19, 2013: 11:45 AM ET

Federal Reserve officials dinged JPMorgan and Goldman for being off on their stress test results. Wells Fargo, however, got a pass.

Wells Fargo CEO John Stumpf

Wells Fargo CEO John Stumpf

FORTUNE -- It pays to be the teacher's pet, even when you are bad at sucking up.

Shortly after the Federal Reserve released the results of its recent stress test last week, Wells Fargo said in its own report that it had no idea how the Fed came up with its numbers.

That's an understatement.

Wells (WFC) said it would lose $1.7 billion in a severe economic downturn. The Fed's loss estimate under the same scenario was more than 12 times that: Nearly $26 billion. Of the 18 banks that took the Fed's stress test, only one, JPMorgan Chase, missed the Fed's estimate by a wider margin. After Wells, Goldman Sachs did the next worse at matching the Fed's results. It was off by a mere $14 billion.

MORE: Is Goldman riskier than it says?

However, unlike JPMorgan (JPM) and Goldman (GS), Wells was given an unconditional passing grade on the Fed's test -- the best grade possible. JPMorgan and Goldman, on the other hand, were told they would have to take the test again. It's not clear why.

The test was supposed to be about whether banks had enough capital -- that is the money a bank has to cover bad loans and investments -- to survive another financial crisis. Wells was deemed to have enough. But so were JPMorgan and Goldman.

Nonetheless, a senior Fed official hinted that the central bank was unhappy with the numbers that JPMorgan and Goldman submitted on its test results. They were too rosy. That seems to be the reason that the Fed is forcing JPMorgan and Goldman to resubmit their capital plans.

It's not clear why Wells isn't being forced to do the same. Fed officials declined to comment. A Wells spokeswoman said the bank was pleased with the results and declined to comment further. Says one veteran bank analyst, "Made no sense to us."

It appears all of the banks tried to lowball regulators on the recent stress test. But Wells Fargo's pitch was the furthest outside the Fed's strike zone. The bank said $32 billion of its loans would go bad in a downturn. The Fed said Wells would have to swallow nearly $54 billion in losses. And some analysts said they thought even that estimate was low. Goldman analyst Richard Ramsden put Wells Fargo's potential loan losses at $58 billion.

MORE: Why higher mortgage rates could boost the housing market

"Even the Fed's numbers in a crisis like the one we had were probably low," says bank analyst Paul Miller of FBR Capital Markets. "Wells has always been an optimistic bank."

Lawyers and other consultants who help banks with regulatory matters say the Fed, in the wake of the London Whale, has become overly cautious about banks that are risking their money in the market. JPMorgan and Goldman have large trading operations. Wells doesn't. And that's why Wells may have gotten the full pass, and its two rivals didn't.

Anat Admati, in her new book The Bankers' New Clothes, which is about how to make banks safer and has been been getting a lot of buzz in policy circles, says the emphasis is misplaced. Traditionally, banks imploded because of bad loans. That was the case in the last financial crisis. If anything, the trading operations at JPMorgan and Goldman made them safer in the downturn. So while she's not against it, Admati thinks the Volcker rule and other efforts like it to crack down on the banks' trading arms misses the point. The same could be said of the stress test.

So for now, Wells Fargo remains the regulator's favorite big bank. That's probably what the stress test really told us, not that it was actually any safer.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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