Monday, May 11, 2009


Want to read some mind-numbingly laid-back specs for the banking industry? Take a look at the methodology outlined by the Federal Reserve for the infamous "stress tests" that banks are supposed to follow.

Ultimately, the goal is for troubled banks to provide information that will give us an idea as to whether they could survive several "stressful" economic scenarios. The pathetically low standards for the Stress Tests - also known as The Supervisory Capital Assessment Program: Design and Implementation - are only matched by the program's willful ignorance of the banking system's insolvency. Jule Satow outlines some of the problems here:

1. Banks Get to Determine Risk-Weighted Asset Values: Are you kidding me? We have to accept what the banks - who have been so good at honoring their fiduciary responsibilities in the past - say their toxic assets are worth? They're already loathe to renegotiate troubled home mortgage contracts because they don't want to reduce the value of their loan portfolios, so to expect the banks to be honest with us about their total assets because "it's the right thing to do" is asking for trouble.

2. Debt-to-Capital Ratio of 25 to 1 are Allowed: This is far higher than the 12 to 1 ratio that the SEC required of banks before the fateful 2004 decision that allowed the five largest investment banks to increase debt loads (discussed in Chapter 12 of my book, p. 275).

3. An 8.5% Loss Rate for Commercial Real Estate Portfolios: This not only depends on consumer spending picking up (have you seen consumer debt loads?) but is a very generous standard since default rates on commercial real estate have quintupled since the beginning of 2008.

Making matters worse is that little to nothing is said about the $50 trillion (about 3 x's our nation's GDP) in derivative trash that's still on the books ... or that several of the largest bank's exposure to derivatives exceed their total assets ... or that the FDIC is essentially running on fumes with approximately $50 billion left to cover 8,000 banks with about $7 trillion in deposits ... or that many of our financial institutions are pretty much insolvent zombie banks without the Fed's life support.

With these embarrassingly weak standards, and developing realities, I'm surprised that the Stress Tests don't require bankers to take a vacation in Tahiti. You know, to take the edge off of their stressful days from making stuff up.

Seriously, as Anthony Citrano suggests, the stress tests are akin to you going to your medical doctor for a physical that you need to pass for your job (after you've spent a year partying and eating as if you were in a Roman orgy) then having your doctor ask you if you want a clean bill of health.

Look, unlike Rush Limbaugh and the Republicans in Washington, I want President Obama to succeed. We need to nationalize failing institutions and the zombie banks, which will allow us to force failure on the clowns and the toxic instruments they helped create.

Unless the banks are weaned from government life support, these Stress Tests do little more than tell us what the banks want us know.

- Mark

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