Stress Test Criteria, Very Conservative

TARP, TALF, PPIP.  TBTF.  How many more acronyms can we have?  Today’s Stress Test might as well just be called the “ST.”  Technically, this is called the Supervisory Capital Assessment Program, so we will call it the “SCAP” for the future.  At 2:00 PM we got to see what the parameters were and it comes as no surprise that most banks are said to have enough capital.  This is a 21-page report dealing with “severe but plausible” downsides in the economy. The stress tests were applied to the bank holding companies with more than $100 billion of assets at the end of 2008, as these have two-thirds of the assets and about half of the loans in the banking system.

The release was said to be to help assist analysts and other interested members of the public in understanding the results of the Supervisory Capital Assessment Program, which are expected to be released in early May.

The economic assumptions are as follows:

• Real GDP’s average baseline is -2% for 2009 and +2.1% for 2010.  The alternative more adverse levels are -3.3% for 2009 and +0.5% for 2010.  The average baseline for unemployment rates is 8.4% in 2009 and 8.8% for 2010.  The alternative more adverse levels were 8.9% in 2009 and 10.3% in 2010.  Remember that these are averages, not year-end levels.  For housing prices the test assumes a -14% price change in 2009 and -4% in 2010, but the alternative more adverse drop is -22% in 2009 and -7% in 2010.

Maybe these will be the real levels of the economy.  But what if the bailouts and the rescue packages don’t work as well as we all hope?  What if rates start to get out of hand? These might be fine for baseline analysis, but the true baseline for “further stress” could have arguably been much closer to what was used as the ‘alternative more adverse drop.’

The Federal Reserve is noting that any banks directed to raise new capital should not be viewed as insolvent .  Banks will have several days to challenge the findings, which will be released in the week of May 4.  The goal is to allow these largest institutions to have enough of a buffer that they can keep lending during times of stress.

Our take is that the government’s “alternative more adverse drop” is still too optimistic.  Maybe it isn’t, but that might be a more fair base-line room for analyzing institutions under stress.

Here is the link for the full data from the Federal Reserve.  This will probably not surprise anyone: this still leaves more questions than answers.  You can now use the same argument to support exact opposite answers.  The data suggests the bulk of banks are fine.  And it also suggests that they are all, or mostly, undercapitalized.  You will probably see just as many arguments on both sides of this argument all weekend long.

JON C. OGG