Monday, May 11, 2009

Bank "stress test" looks like a sham

The "stress test" to separate the sheep from the goats among banks apparently was wired by the government to present a false picture of their general financial health. The Wall Street Journal broke the news:
The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining. In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

This after a week of carefully "leaked" information from the stress tests to suggest that with a few exceptions, the banks were the picture of health, no time bombs on their books they couldn't deal with. Investing suckers rushed to put their money on the table and bank stocks (along with many related names) were on the hop.

Your blogger was skeptical. Unfortunately there was no way to make money on it, because there was no way to tell how long the suspected deception would go unchallenged, and a short position could unravel quickly if the financials carried on rallying. But as it turned out, the banks' days of wine and roses seem to have run out already.

John Hussman, a principal in the Hussman Funds, says the regulators have failed an ethics test.

To some extent, it is not possible to get full and fair disclosure using the method that regulators used in the first place, since it relied on banks' self-estimates of their potential losses in a further economic downturn. These of course being the same banks that made the bad loans, and have already proved themselves vastly incapable of loss estimation and risk management. Moreover, the Fed only asked for loss estimates for 2009 and 2010, not beyond – “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.” This period specifically excludes the window where we can expect the majority of “second wave” mortgage losses to be taken, as it does not capture any losses that will emerge as a result of mortgage resets from mid-2010, through 2011, and into 2012.

The “stress test” procedure also conveniently excludes any potential mark-to-market losses during 2009 and 2010, as banks “were instructed to estimate forward-looking, undiscounted credit losses, that is, losses due to failure to pay obligations (‘cash flow losses') rather than discounts related to mark-to-market values.”

Why should we be surprised? In the minds of the present administration, the stock market is just one more institution to be manipulated by the Obamintern, which hates everything about America except its pliable minorities and its financial overlords.


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