So now the "results" are out. If you believe any of it.
A banking organization holds capital to guard against uncertainty. Capital reassures an institution’s depositors, creditors and counterparties‐‐and the institution itself‐‐that an event such as an unexpected surge in losses or an unanticipated deterioration in earnings will not impair its ability to engage in lending to creditworthy borrowers and protect the savings of its depositors.
Well there's our first problem, right in the first paragraph.
A sound fractional lending institution (that is, any banking organization) holds capital against any unsecured loan in the total amount of that unsecured debt so that if and when the borrower does not pay, it has something with which to replace the capital that it loaned out without security.
One instantaneous piece of bad news lept off the paper:
In combination with the losses already recognized by these firms since mid‐2007, largely from chargeoffs and write‐downs on the values of securities, the SCAP results suggest financial crisis‐related losses at these firms, if the economy were to follow the more adverse scenario, could total nearly $950 billion by the end of 2010.
By this definition we already know the "test" is a joke.
My best estimate for residential mortgage losses only is between $2.5 and $3 trillion. The IMF recently almost doubled their loss estimate from $2.4 to 4.1 trillion, Roubini has published numbers north of $2 trillion, and so have a number of other well-respected economic analysts.
That The Fed is claiming that total losses will less than half my best-case figure and one quarter of the IMF's stretches credibility - and that's being polite.
Now on to methodology:
The participating BHCs were asked to estimate their potential losses on loans, securities, and trading positions, as well as pre‐provision net revenue (PPNR) and the resources available from the allowance for loan and lease losses (ALLL) under two alternative macroeconomic scenarios.
Note: They asked the banks, they did not send in a team of examiners to look at the books independently. So the base data that was ingested into this process in fact came from the banks themselves, not from independent, outside examination. As a consequence it is fair to ask where the valuations came from and how they are supported, including the models and other information used to develop these figures.
This data is not disclosed.
Second, some of the data points and "expected losses" are comical. For example, the banks are expected under the "more adverse" situation to believe that prime mortgage losses will not exceed 4%, and ALT-A (liar loans and Option ARMs) will not exceed 13%. HELOC loss (most of which is unsecured!) is expected not to exceed 11%.
Commercial Real Estate, in total, is not expected to produce more than a 12% loss.
These values are comical. In particular ALT-A losses in many securitized portfolios from 2005, 2006 and 2007, where we can look them up, are already reflecting 30% or more of the pool in foreclosure, 90+ days in default or under declared bankruptcy. To believe that the total loss will not exceed 13% across these portfolios, nearly all of which are concentrated in severe bubble states such as Florida and California (this is why those loans were so popular in the first place due to the bubbly nature of prices!) is lunacy. Home prices have in many of these areas already fallen by 50%. Recovery on these notes is likely going to be 30% or so, with half ultimately defaulting under an "adverse" scenario. This will produce losses closer to 40% of the entire pool, not 13%.
HELOC assumptions are even worse. As subordinated debt if the first mortgage is not satisfied these are literal zeros. Expecting 8-11% loss under a severe economic situation is lunacy.
There are likely banks where these ratios make some sense. For example, a bank that only wrote notes on property in Kansas, where there was no big bubble in values, might be able to support that sort of valuation and loss estimates.
A similar bank that wrote mostly California exposure has no chance whatsoever of limiting losses to this figure under the "more adverse" scenario.
If these numbers have any sort of credibility then this paper should be trading at 85 cents or so.
The truth is that you can't find a bid for anything over 40 cents, and the reason is that for those pools where the internals are exposed the known loss figures are high enough to make the actual "today" value of that paper 40 cents, not 85 or 90.
Yet the entire predicate of this "stress test" is that these literally magical values form an accurate assessment of the risk and loss expectations of paper written for more than the collateral is worth with zero underwriting beyond the ability to fog a mirror!
That's insane.
But it didn't end there. Apparently some of the banks didn't like the numbers and lobbied for changes; specifically:
Some major banks managed to wrest concessions from the government in closed-door negotiations over their "stress tests" that helped them put the best face on their results, financial analysts, industry officials and sources said.
The banks were intent on sending a message that they were strong enough to weather the economic storm and didn't need additional capital infusions from the government that could all but nationalize their franchises.
So even with magical thinking the results weren't good enough so the executives had to resort to putting lipstick on the pig, and what's with this "closed door" stuff? I thought we were getting transparency? I guess that's just a word, eh?
My view is similar to that of Weiss Research, which said:
Washington, DC, May 5, 2009 — At least 15 of the nation’s 19 banks undergoing federal stress tests this week would fail a stricter test based on more objective economic assumptions and stricter evaluation procedures, according to an analysis released today at the National Press Club by Martin D. Weiss, Ph.D., president of Weiss Research, Inc.
“The stress tests results are akin to ratings,” declared Weiss, formerly the president of a national rating agency. “But no objective rating agency would stand behind them. The exams are too easy; the banks get to take them home with cheat sheets; and if they don’t like their final grade, they can appeal for a better one. If, despite all this, some large institutions still come up short on capital, it will imply far deeper troubles than the Treasury or the Fed dare admit.”
Exactly.
One final question: If indeed these "stress tests" all say that the banks are ok without any major capital raise, and they can "simply" convert preferred to common to "shift around" some of their capital to a "better" place, then by law The Federal Reserve is required to shut down all of its "extraordinary banking programs" right now, since there is no longer an emergency that requires their "extraordinary intervention" and in fact there never was!
Of course that's not going to happen and the reason is that if The Fed did so every one of these banks would have their garbage puked back at them and instantaneously be recognized as insolvent - and The Fed knows it.
Once again, America, you've been whitewashed by a bunch of insiders who have infested our government and then between the executives and government have conned you.
Indeed, Ken Lewis was on CNBC this morning and all-but-admitted that "the rules didn't apply", a fairly strong implication (if not an admission) that the law was simply ignored when it was inconvenient.
What makes you think its being followed now?
Further, Lewis also said that if unemployment continues to ramp neither he or any other bank will find it reasonably possible to make money due to default rates on consumer loans, especially unsecured paper such as credit cards and that the government will find that "politically unacceptable."
Well?
We're about to get an unemployment number that will be within a point of the worst case scenario in these "stress tests", and the true internal unemployment number (U-6), which represents the number of people not working far better than ignoring anyone inconvenient to count is several points higher than the "worst case" - and its only May!
American Idol is almost over; I recommend exercising your rights and responsibilities of citizenship and raising hell over this faux piece of garbage that was sold to America as "hope".
Oh, and if you've been long these bank stocks and have been smiling as they have, in many cases, gotten within 20-30% of their "boom time" high in stock price?
I'd be selling.
Disclosure: No position in any of the 19 named firms.
Audio Streams
