Market Reflections

Thoughts, ideas and musings on current state and evolution of financial markets

Bank Stress Tests

Some knowledgeable folks had differing opinions on the value and meaning of bank stress tests. People who have worked for large banks and know their business inside-out are of the opinion that the only real goal for the tests was to fool the public to believe that the banks are fine.

Should the government succeed in this effort then the investors will beef up the banks buying their stock. The consumer will start spending again pulling the economy moving by multiplication effect and we will appear to be out of trouble fast in a “V” shape recession. If that happens then the unfortunate side-effects will be steep drop in dollar value, skyrocketing energy and commodity prices with gasoline at the pump making driving prohibitive, rampant inflation and very high market based interest rates (e.g. mortgage rates).

Should the consumer refuse to believe the president’s Easter Bunny fairytale and remain in the sidelines for few more quarters then we will probably be in for a long drawn out “U” shape recession with recovery nowhere in sight. The market loses patience fast and will sell. “Cracks” in bank balance sheets will become obvious again, but there will be no more bail-out money available. Government’s renewed efforts to “talk us out of recession” will become futile and efforts to borrow us out of debt will become more and more expensive. This government will probably remain for one term only. On a positive note, food and gasoline prices will fall, interest rates remain low, high end retailers will fail and people in America will re-learn to live by their means.

House already admitted that the budget deficit will topple $1.8 Trillion in first of the coming series of upward revisions of budget deficit. That means borrowing will have to bring in half of the budget. This far they have only managed to talk the stock market deep into irrational exuberance. Rest of the economy continues down with long term unemployment rate (marginally attached, discouraged, part-time for economic reasons workers) up from 15.6% to 15.8%. Our rubberstamping congress will give the administration everything they want, except one thing they cannot give – the time. Read Napoleons’ advice to Obama here.

Remains to be seen which of the scenarios will play out. Whichever does, very volatile markets are likely in short term. Use short term strategies to trade.

The material
Stress-test results ignore bad bank assets

The real objective and meaning of stress testing “private banks” from WSJ Online:
How the Stress Tests Stopped the Market Bleeding

This is not new. Same was done by Goebbels in Germany before and during WWII and projected by Ayn Rand “Atlas Shrugged” to happen in America. Read history to understand better what is actually going on.

The process
Banks Won Concessions on Tests. Fed Cut Billions off Some Initial Capital-Shortfall Estimates.

End result
The Stress Test Result: Banks Scramble to Issue Common Stock. They have 6 months to accomplish that.
Official stress test results have following assumptions:
1) The total loss rate for loans calculated by the regulators is 9.1%, a level that exceeded that seen in the 1930s.
2) Tier 1 capital ratio of 6% and Tier 1 Common capital ratio of 4%.
3) Estimated losses of $600 billion over 2009-2010.
4) Estimated revenues and reserves build over next 2 years $415 billion–> estimated need for additional capital buffer of $185 billion by the end of Q4 2008. Note, the cut-off time for the data used in stress test and the regulatory environment (e.g .FASB rules in force at that time)

By Q1 2009 higher revenues (most because of FASB accounting rule modifications) changed so that the additional total capital requirement amounts to $75 billion, of which: BofA: $34 billion; Wells Fargo: $13.7 billion; GMAC: $11.5 billion; Citigroup: $5.5 billion (after signaling already that it will request to convert the government’s $45 billion preferred equity stake into common equity); Morgan Stanley: $1.8 billion. Treasury’s injected preferred equity stake is $218 billion. Remaining TARP funds available are $110 billion. Treasury expects $25 billion in TARP repayments soon.

About The Author

Raymond has been active on financial markets since 1989 mostly trading commodity and currency futures and options. Trading systems and strategies, statistical and empirical modeling of markets have been his focus almost two decades now. Few projects are listed on his website. Raymond believes that every person could and should take responsibility and protect his/her finances. At least to be able to identify scams and fraud before giving life savings to a crook. It is not enough to rely on government because way too often officials (elected or other) are part of the scam themselves. Whether their reasons are campaign contributions, cushy job or lack of knowledge to understand the consequences of their actions none will help the victim. Recent succession of governments each trying to bankrupt the country faster than the previous it may very well happen that the world largest Ponzi schemes Social Security and Medicare will go down with the country. Without prudent financial decisions now one may sorely miss every penny of his/her savings lost to scam artists and “professionals”. To help out Raymond is sharing with users his analysis and views on variety of economic, financial market and trading issues.


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