Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Stress Tests: Another Case of "Mission Accomplished"?


Some undercapitalized banks likely to escape detection.

I have received several requests to comment on the bank stress tests.

In doing so, let me start with this "perspective" on the stress tests, which was first offered by the Treasury back on February 10, when Secretary Geithner announced the Financial Stability Program:

"Increased Transparency and Disclosure: Increased transparency will facilitate a more effective use of market discipline in financial markets. The Treasury Department will work with bank supervisors and the Securities and Exchange Commission and accounting standard setters in their efforts to improve public disclosure by banks.

"This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending."

At the risk of repetition, let me offer that final sentence again:

"In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending."

Understand that my point is to neither agree nor disagree with the approach, but rather to highlight the ground rules for the stress test. But as a consequence, I would offer that the stress test is likely to only identify the worst of the lot, not the entire population of undercapitalized banks.

Don't get me wrong, the approach that the regulators have taken, as outlined in Friday's Federal Reserve white paper, is fundamentally sound. The regulators looked at banks' capacity to absorb losses based on what appear to be reasonable run rate revenue assumptions, and even included a whole range of off-balance sheet exposures (derivatives, securitizations, undrawn lines of credit etc.)

But to me, the regulators failed to be conservative enough in their economic forecast, and more importantly, in their severity-of-loss assumptions. (And, for those not familiar with the term, "severity of loss" is how much per dollar of loan outstanding will ultimately be written off.)

But in fairness to the regulators, I doubt people would believe what will ultimately be the losses on commercial real estate today any more than they would have believed our current loss levels in residential real estate back in 2007. (See Fil Zucchi's Ten Reasons Commercial Real Estate Won't Rebound, and its discussion of Goldman (GS), SRS and IYR, for more on this.)

To me, the most important aspect of the stress test is not which banks fail, but what happens to the banks that pass. Arguably, all of the banks that pass should be permitted to repay their TARP preferred. But candidly I have my reservations about that, especially as each of the 19 banks is arguably "systemically significant." And if I were FDIC Chairwoman Sheila Bair, clearly the person most at risk if a "passed" bank ultimately fails, I would be lobbying hard to prevent any of the 19 from repaying the TARP now or any time soon.

From my perspective suggesting that a "pass" means victory, is a little like George Bush declaring "Mission Accomplished" on the USS Abraham Lincoln 6 years ago. Rather than permitting the strong to turn in their guns, we ought to be encouraging all of them to use this lull in the battle to bring in reinforcements.

From what I see from my watchtower, they -- and we -- are all going to need them.
< Previous
  • 1
Next >
Position in FAZ, JPM
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Featured Videos