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Bank Stress Tests: Major Sham??

Posted by Larry Doyle on April 8, 2009 11:35 AM |

failing-grade1Why is it urban school dropout rates are 50%? Well, I am sure there would be as many reasons for that horrendous statistic as there are dropouts. The fact of the matter is, though, the state of urban education has promoted a phenomena known as “social promotion.” If students aren’t qualified to do the work, testing has been gamed, standards have been lowered, and corners have been cut. As a result, urban education at this stage is an unmitigated disaster. What does this have to do with the current state of our economy and the world of finance? I am glad you asked.

If banks, much like students, are not required to pass rigorous testing, then “social promotion” in finance will produce results not unlike those in education–underperformance and ultimately an inability to compete on the global stage.

Against that backdrop, I personally looked forward to the results of the Bank Stress Tests. Let’s finally get an honest assessment of the “students.” Let’s see how they have performed and let’s project to see how they will perform!!

As with any test, the results are only meaningful if the process and proctor have unquestioned integrity. The proctors for the Bank Stress Test are none other than Treasury Secretary Tim Geithner and Fed chair Ben Bernanke. Why is a testing authority of the magnitude of FDIC, led by Sheila Bair, not more involved in the process? Ms. Bair is the one individual in our country with the greatest level of interaction with and understanding of the student body, that being the banking industry as a whole and individual banks specifically.

What does the FDIC, led by Ms. Bair, have to say about the upcoming Bank Stress Tests? The New York Post provides a CHILLING perspective:

The stress tests the government are about to conduct on some of the nation’s largest banks is being blasted by insiders at Sheila Bair’s Federal Deposit Insurance Corp., who say it’s a pointless exercise that’s more sizzle than steak.

The FDIC’s basic beef with the stress test is that it is not a credible way to assess how much additional cash beaten-down banks will need to weather what many Wall Street experts predict will be more losses in the coming months.

The tests are conducted by the Treasury Department and the Federal Reserve on the nation’s 19 biggest banks, including behemoths Citigroup, Bank of America and JPMorgan Chase.

“It’s a sham,” one source told The Post, describing the test as an “open-book, take-home exam” that doesn’t actually work.

While specific details are still being worked out, the Treasury and Fed’s tests are expected to determine how banks might perform under the assumption that unemployment ratchets up and overall economic conditions worsen beyond what the market has seen so far.

However, Bair and others argue that the remedial test won’t be able to determine accurately how much each bank will need in the future.

These people say some banks found in solid shape today may later go to Uncle Sam hat in hand as the markets worsen. They also note that anything done now will largely be arbitrary.

Officials from the FDIC declined to comment.

The FDIC’s panning of the stress tests highlights the growing rift between Bair and Treasury Secretary Tim Geithner over how to fix the ailing financial sector.

Many high-profile analysts already are voicing the concern that losses will pile up in areas most of Wall Street hasn’t watched closely, such as residential and commercial loans that are currently on banks’ balance sheets.

Banks can house these assets on their balance sheets at nearly their full value if they hold them to maturity. However, the credit crunch has made many of these loans worth far less. For example, market players said banks today will get anywhere from 60 cents to 80 cents on the dollar for option ARMs and home-equity loans they own.

Critics also argue that the stress test fails in comparison to other valuation methods such as Basel II, which took years to develop and was to serve as a global standard for assessing how much capital a bank should hold in relation to its risk.

“How is the Fed and the Treasury over a couple of weeks supposed to take a weird set of macroeconomic assumptions and come up with a number [for banks]?” one source asked.

The transparency of the test has also been called into question since expectations are that the Treasury won’t disclose specifically which banks need more cash to remain stable and which will pass muster.

Treasury expects to release some of its findings at the end of April.

Make no mistake, scathing insights such as these do not just happen to end up in the press. They are strategically released by people who do not want to be implicated in the future for not having provided fair warning. Ms. Bair, specifically, and her colleagues at the FDIC are much like many exemplary parents of students trapped in an urban school district. Their frustration is palpable because they care so much about the future of their children.

Let’s review some of the parents’ comments about the testing process: pointless exercise…more sizzle than steak…not a credible way…SHAM…open book, take home exam…transparency called into question…

I can hear Secretary Geithner now, “Best of luck in 7th grade, boys and girls.”


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