Isn’t it interesting that when everything was fine but about to tailspin out of control no one was worried? But now that conditions are not-so-good the authorities, in a effort to ‘appease’ our fears, have embarked on a course of action playing the game ‘what if”…What if ‘what’ you ask? Well what if, ’things get even worse?’
Isn’t that an encouraging game to play? And how many of us really want banks to beef up even more capital just as the economy is preparing to bottom? Whose money will they do this with?
Sure regional banks may still get worse. Banks with traditional mortgage loans did not have to mark them to market if those loans were ‘threatened’ were still performing. But securitized mortgages at money center banks and held by securities firms were being marked lower based on actual events as well as speculation. Now with those onerous and pro-cyclical accounting rules (mark-to-market) out of the way, the threat of securitized security mark downs is lessened but small banks may run into the buzz saw of reality.
In part this is a warning that business cycles send out ripples of bad events that hit some sooner and some later. It is not necessarily a sign of worsening in the cycle if regional banks begin to accrue losses on their loan and mortgage portfolios. It is just part of the current cycle playing itself out.
So, what’s the point? I am unsure of the role that stress tests are supposed to play. Are they supposed reassure us that banks are okay even under much worse conditions? Are they supposed to motivate banks to raise more capital? If so, how does that wok? Telling a bank it is as good as insolvent is not usually a good way to attract suitors, unless by that you mean the M&A crowd. Is that the idea? Is it to push banks and their shareholder/bondholders to cut new deals they would not be willing to cut absent the push near the precipice from the Fed’s? Is this the ‘GM strategy’ applied to banks?
Enquiring minds want to know…
You have heard my rant on stress tests before. If banks have securities they cannot evaluate now, how do they evaluate them under hypothetical and worsened situations? That part of it does not even make sense. It is not just voodoo economics, it is illogic in action and the brain child of Tim Geithner.
So let’s wait for, then read, these stress test results with real open minds about what they are, what they did, and they have as their objective. It is far from clear what role they are playing and whose purpose they serve. Be careful about getting too reassured by the results.