Stress Tests: Drama, Delays and Rose Colored Glasses

Econ 101 Blog ^ | 5-09-09 | newshound

[NEWSHOUND]

Delays, leaks and high drama. The Stress Tests had Wall Street waiting with bated breath. But did the tests really deserve all the hoopla? Did the fact that the banks 'passed' mean that we can all breath a sigh of relief?

In spite of the fact that the Bulls have taken the test results as an 'all clear' for another run up on the markets, I tend to be more skeptical. Why? Because a test isn't a test if you can negotiate your own results.

To be honest, the fact that all the banks would pass was a foregone conclusion. The government couldn't risk a subsequent run on banks and loss of consumer confidence if they failed. So naturally, the criteria had to be massaged accordingly. Take a look at the scenarios: we have already reached the criteria outlined in the 'bad' outlook, as well as many of the criteria for the 'worst case' outlook. If that's so, then obviously the banks are already under capitalized, but how can these tests give us any information about future performance? The fact is that they can't. But even more alarming, from my point of view, is that the results really aren't the results anyway.

When the results of the tests were first compiled, the banks didn't like them. Instead of going public with their findings, the government then 'negotiated' the outcome with the banks (hence the delay in the release date). These negotiations allowed the banks to reduce the amount of capital requirements that the government was about to say that they needed. Pretty neat trick. I don't know about you, but in my 'school' a test isn't a test if the test taker can change their final score when they're unhappy about the outcome.

But even if the government had stood by their original findings, how reliable could they be? After all, they haven't had a great track record so far in predicting future outcomes based on 'stress scenarios'.

As William Black (an Associate Professor of Economics and Law at the University of Missouri and former bank regulator) says, Fannie Mae, Freddie Mac, AIG and IndyMac were deemed to have "passed" much more stringent government stress tests before their respective failures.

Let's review the history:

* Fannie Mae and Freddie Mac: In July 2008, Treasury Secretary Paulson testified that Fannie and Freddie were "adequately capitalized" under the test. Then in August 2008 he stated, "even in [the] most severe stress tests, [Freddie Mac shows] losses ... less than $5 billion." What were the actual losses? They were 20 to 40 times greater.

* AIG: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those [Credit Default Swaps] transactions." AIG claimed in 2008. "Using a severe stress test ... losses could go as high as $900 million." And the actual losses? They were 200 times greater!

* IndyMac: Sold over $200 billion of "liar's loans." Actual losses: 160 times greater than its tests had indicated.

"The examinations and stress tests are shams," says Black.

Even the government's own results seem to be contradictory. We have to ask ourselves, if the government sees up to $599 billion in additional bank losses, then why are they requiring banks "only" raise $75 billion? That would suggest that the government thinks the banking sector is currently overcapitalized by $525 billion. That makes no sense.

According to Black, "It's in the interest of the financial community to send this propaganda out. [What's] remarkable [is] not that they do it but that it still works."

We've been lied to over and over again, but like an ingenue, we remain convinced that 'this time it will be different.' Perhaps it is just our attempt to make optimism triumph over reality.

But we had all better hold tightly to those rose colored glasses. Black predicts another wave of foreclosures and future bank losses that could total more than $2.5 trillion as opposed to the government's $599 billion estimate.

The question is, how will investors handle the huge losses to their college and retirement savings that could result from investing in banks that the government told them were safe?

"Once people learn they're being lied to, they react very badly," Black says. "And of course this is not the first lie."

[NEWSHOUND]

If you think we're out of the woods with the banks, you've got another think coming. The banks and the government are, once again, trying to sucker investors to part with their hard-earned money to prop up the banks and keep the exec's in their houses in the Hamptons. Of course judging by the markets on Friday, we seem to be buying into it, so perhaps we're getting what we deserve. I just hate to see more and more average Americans robbed of the savings that they've worked their whole lives to accumulate. There are rough waters ahead, so stay prepared.

[jveritas]

The stress test was all fabrication to portray a fake positive outlook, to drive more fake rallies at Wall Street, to convince the populace that Obama socialism is working, and to force more socialism. Where in reality Obama socialism is destroying and will continue to destroy with more severity the foundations of our economy.

Only fools will be investing in the stock market now because the Wall Street firms are using the fools money to create those fake rallies.

[NEWSHOUND]

You’re right. But it’s even more insidious than that. They want to divert our attention from the upcoming PPIP auctions that will enable banks to buy toxic assets from each other at the government’s expense and leave the taxpayer holding the bag. This is going to leave us on the hook for TRILLIONS of dollars and makes TARP look like chump change.

For more info on how this is going to work, check out my ‘Econ 101’ blog archive for March 23 at http://myecon101.blogspot.com