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The Crisis Is Over - For Now


But what if economy is worse than projected?

Editor's Note: James Kostohryz was formerly the head of international investments for a major Brazilian investment bank.

The good news: The stress tests are credible. The projection of potential losses of $599 billion at the nations 19 largest banks is a plausible scenario. Therefore, it won't be easy for bears to claim that these stress tests are "rigged," or that they were prepared with "rose-colored glasses." The stress tests project losses of around 10% of total mortgage loans, which implies default rates of around 20%. The stress tests also project average credit-card losses of 23.5%.

These aren't lowball estimates for losses by any means. These types of losses would be unprecedented in US history. Indeed, these are reasonably aggressive estimates, and it's quite plausible that losses will never reach theses levels. It's also plausible that losses could exceed the ones projected.

But that's the point. The loss estimates are plausible. They could be lower, or they could be higher. Nobody knows for sure how large they'll be. However, the losses projected are high enough that they're not subject to easy attacks that they're ridiculously low. The fact is that bears have absolutely no way to prove that the losses will be larger.

Sure - there will be bears that will say the loan losses will be greater than forecast. But since the losses projected under SCAP are similar to those experienced in the Great Depression, they'll have to make claims that will likely seem rather extreme at a time when the economy is exhibiting clear signs of bottoming and where "green shoots" are in evidence.

Some bears will complain that the projected losses in the Commercial Real Estate portfolios are too low. But 8.5% isn't exactly a trivial figure, either. Who knows what it will ultimately be?

Many bears will complain that the losses attributed to complex securities, derivatives and various sorts of counter-party exposures aren't aggressive enough. However, precisely due to the complex and opaque nature of these assets, the bears won't have an easy time making their case. In fact, they'll have absolutely no empirical data that they'll be able to base their doomsday proclamations on. Thus, I expect their criticisms will ultimately gain little traction, and that their rantings will fade into the background.

Again, the loss projections under SCAP are plausible. That's all the financial system needs at present to restore functionality. And restoring credibility and functionality to the banking system is perhaps the single most important factor to pulling out of the current recession.

There's more good news, in the short term. To the fact that the loss estimates are credible, one must add the fact that the capitalization requirements are quite high. The level of capitalization that the US government is requiring the banks to maintain is far in excess of the standards in Europe, for example. Thus, the credibility of US banks on the capitalization front is virtually unquestionable.
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