De-Stressing The Stress Tests

A truism of government, regardless of political party, is that when officials tell you something, they mean the opposite.  The large bank holding company stress tests recently conducted by our government is no different:  it is  simply a whitewash intended to dupe the US taxpayer into continuing to bail out a failed financial system instead of doing the just and proper thing of liquidating the system and starting anew.  

On Friday, the Fed released its white paper of the stress test, The Supervisory Capital Assessment Program: Design and Implementation.  You can read it in full, or for those of us who need assistance deciphering government doublespeak, you can read Tyler Durden's Stress Test Cliff Notes .    Here are a few highlights of Durden's analysis:

(1) “more than 150 senior supervisors, on-site examiners, analysts and economists” spent a month reviewing the 19 BHC’s [Bank Holding Companys] that hold two thirds of the country’s bank assets and account for one half of the loans

More than 150 means at least 151.  .  .  .  A typical single bank examination utilizes hundreds of examiners and takes several months. Clearly the next release of public sector productivity numbers is going to astonish.

(2) ”the firms were asked to project…..the firms were asked to provide…etc.”

In other words, the banks tested themselves and the 150 examiners took their word for it. Any wonder they passed?

.  .  .  

(4) “As a result of the loss recognition framework for assets in the accrual loan book, the results of this exercise are not comparable with those that would evaluate such assets on a mark-to-market basis”.

Absolutely. What does the market know anyway? The banks’ models got us into this calamity so damn if they can’t get us out!

.  .  . 

(6) “Each participating firm was instructed to project potential losses on its loan, investment, and trading securities portfolios, including off-balance sheet commitments and contingent liabilities and exposures over the two-year horizon beginning with year-end 2008 financial statement data. “

Again, Treasury outsourced the testing to the banks themselves. So what was the job of the Treasury staff other than to photocopy , collate and file? Was this a Temp Staff? Kelly Girls?

(7) “Firms were allowed to diverge from the indicative loss rates where they could provide evidence that their estimated loss rates were appropriate. ”

I know it looks bad, but believe me, it’s getting better!

.  .  .

(10) “Under the baseline scenario, BHCs were instructed to assume no further losses beyond current marks”

It’s over! Great news!

In other words, the banks were asked to evaluate themselves using less time than bank regulators typically take, using models that do not truly reflect what would happen under the assumed scenarios.  

So, why are we doing these stress tests if they don't really test stress?  The Fed and Treasury are well aware of the capital required to bail out banks and depositors.  Since the Great Depression, the Fed and Treasury have taken the view that the economy and maintaining deposits in a bank is a game of confidence.  (Indeed, in a larger sense, the utility of paper currency - the Federal Reserve Notes we all keep in our wallets - depends very much on the world's confidence in our political and economic system - but that is another topic that involves a discussion of the national debt and the willingness of other governments to finance the debt).   Con games work as long as people believe the con or until their money is gone.  

The trouble is that people are starting to question the system.  When retirement accounts have lost 45% of their value, homes have lost 30% of their value, and banks in which we keep our deposits are insolvent, people have a right to question whether the system in which we placed our faith and credit can endure.  We have all heard stories from our grandparents how banks closed and the depositors money was not there.  We have been reminded of it all our lives, and now we want to protect what we have.  Systems have crashed before even with semi-rational governements.  The Wiemar republic blew up after a banking crisis.  So did Argentina.  I certainly want to have money if the system crashes - not just a credit from the government for only $250,000 (which, after the massive inflation we will experience at the tail end of the receission as a result of the massive "liquidity injection" {meaning printing of money}, will be worth about $2.50).  Because we operate on a fractional reserve system (meaning that your money is not really in the bank, but the banks maintain a sufficient reserve to meet anticipated withdrawals in normal situations), it is in the Fed's best interest to discourage you from withdrawing your money or from selling your bank stock.  If you knew the bank was insolvent, you would withdraw your money immediately and find another safe haven.  The Fed needs you to have confidence that the bank can provide the money when needed.  That is why these fictional stress tests are created.  

So, what can you do?  Tell your representative to stop the nonsense.  Let the bad banks fail and press the reset button.  In the meantime, secure your assets.