Stress Tests Were Definitely Stressful Enough [View article]
Though I disagree with the thesis, you present thoughtful arguments for your position.
You make the point that the stress test sceptics are hinging their case on the unemployment rate given to the adverse scenario but I think it is important to note that the adverse scenario also assumes home price declines of 22% in 2009; as of the end of the first quarter the decline was 19% as measured by Case-Schiller.
This metric is every bit as important as unemployment and the sceptics are not exploiting all that is available. Further, it is my view that the stress test horizon did not extend far enough, a view shared by Elizabeth Warren and others; the current recession can easily give way to an anemic recovery that then morphs into another recession. Even of this does not materialize, then we should at least be prepared for a new normal characterized by sub-par growth and slow employment gains.
The shape and amplitude of the economic recovery is ever bit as important as loan loss rates and projected bank losses. Under the new normal legacy loans and securities, and their adverse effect on bank earnings, will be around longer than 2010 and this will be anything but a typical credit cycle; legacy chargeoffs will linger around far longer than usual and will be exaccerbated by imminent Alt-A resets and CRE rollovers.
And this type of economy will hardly provide the opportunity for the ninetenn largest BHC's to earn $362 billion over the course of two years; according to the FDIC, the entire banking industry...at its peak.....earned $186 billion in 2006. Viewed through any lens these numbers look optimistic, particulary for an adverse scenario under a stress test.
And while we can debate the strenuousness of the stress tests, we should be able to agree that there is no point in subjecting the banks to such a test unless they are demanding.
Banks Negotiate Watered Down Stress Results [View article]
Here is another gem from Calculated Risk who quotes Roubini, confirming my suspicion about giving extraordinarily wide birth to the banks for estimating "earnings" over the next twop years. The IMF calculates the entire industry will earn $300 billion while Treasury is content, if not happy, to accept $362 billion as a working estimate for the nineteen largest banks. The quote from Calculated Risk:
"Second, the capital/needs of these banks depend on a race between retained earnings before writedowns/provisioning that will be positive given a high net interest rate margin and the losses deriving from further writedowns. It appears that regulators have overestimated the amount of such retained earnings for 2009-2010. The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario. Thus, ex-post capital needs will be significantly higher if net retained earnings turn out to be lower than assumed in the stress tests."
Banks Negotiate Watered Down Stress Results [View article]
Thanks John.
I was frustrated with both the outcome and its presentation; after downloading the file from the Fed, I could not reverse engineer the math used to calculate the SCAP requirements. Part disclosure and part politics.
Picking up on your theme, the original SCAP buffer estimated for BAC, WFC, FIFT and C was $105 billion; this was later negotiated down to $54.3 under the now familiar arguments abouts earnings and the ability to sell stuff. This accomodation, which results in a reduction of required additional capital to the tune of 48%, dilutes the the integrity of the entire exercise.
It was either in Time or the WSJ that someone quoted as saying these reduction are reflective of the entire process, suggesting the exerecise was unterdtaken more to calm jittery markets than it was to really discover and repair the health of the nation's banking system.
Using Fed numbers from the stress test, we can under the adverse scenario, which is now the expected case, look forward to an additional $600 billion in bank losses through 2010. We can also expect banks to offset $362 billion of this number through earnings; this represents annual returns on risk weighted assets of 2.3%. BAC earned 2.2% in 2006 and 1.1% in 2007.
In addition to fudging the numbers to make everybody happy, we are essentially desiging a system wherein the banks can earn there way out of this mess. And in constructing the system, we probably have maximized the potential for bank earnings and, perhaps, understated likely losses.
I think the problem is larger than money; I think the fundamental problem is that investors do not believe the administration has a viable plan to restore stability to the banking system and systematically deal with the core issues facing the sector.
Under both Bush and Obama, the TARP program has lacked clear goals, has been implemented in piece meal fashion and has suffered from lack of transparency. From the very beginning, the U.S. government made the mistake of addressing each major bank failure differently: aiding the takeover of Bear Sterns by JPMorgan, allowing Lehman Brothers to go bankrupt and then dumping $180 billion into AIG.
Under Geithner, there has been his underwhelming perfromance as a speaker and his inability to inspire confidence by communicating a thoughtful, comprehensive plan. Details of the stress test were slow to materialize and then there were the nagging questions of which capital ratios were to be used in guaging solvency. And there is the suggestion that purchases of preferred shares will be calibrated as losses occur.
Finally, when the government increased its stake in Citi to 36% and infused more capital into AIG, the markets took this to mean the problems are large, never ending and too big to be fixed. TARP has lost credibility with the market.
Stress Tests Were Definitely Stressful Enough [View article]
You make the point that the stress test sceptics are hinging their case on the unemployment rate given to the adverse scenario but I think it is important to note that the adverse scenario also assumes home price declines of 22% in 2009; as of the end of the first quarter the decline was 19% as measured by Case-Schiller.
This metric is every bit as important as unemployment and the sceptics are not exploiting all that is available. Further, it is my view that the stress test horizon did not extend far enough, a view shared by Elizabeth Warren and others; the current recession can easily give way to an anemic recovery that then morphs into another recession. Even of this does not materialize, then we should at least be prepared for a new normal characterized by sub-par growth and slow employment gains.
The shape and amplitude of the economic recovery is ever bit as important as loan loss rates and projected bank losses. Under the new normal legacy loans and securities, and their adverse effect on bank earnings, will be around longer than 2010 and this will be anything but a typical credit cycle; legacy chargeoffs will linger around far longer than usual and will be exaccerbated by imminent Alt-A resets and CRE rollovers.
And this type of economy will hardly provide the opportunity for the ninetenn largest BHC's to earn $362 billion over the course of two years; according to the FDIC, the entire banking industry...at its peak.....earned $186 billion in 2006. Viewed through any lens these numbers look optimistic, particulary for an adverse scenario under a stress test.
And while we can debate the strenuousness of the stress tests, we should be able to agree that there is no point in subjecting the banks to such a test unless they are demanding.
Banks Negotiate Watered Down Stress Results [View article]
"Second, the capital/needs of these banks depend on a race between retained earnings before writedowns/provisioning that will be positive given a high net interest rate margin and the losses deriving from further writedowns. It appears that regulators have overestimated the amount of such retained earnings for 2009-2010. The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario. Thus, ex-post capital needs will be significantly higher if net retained earnings turn out to be lower than assumed in the stress tests."
Banks Negotiate Watered Down Stress Results [View article]
I was frustrated with both the outcome and its presentation; after downloading the file from the Fed, I could not reverse engineer the math used to calculate the SCAP requirements. Part disclosure and part politics.
Picking up on your theme, the original SCAP buffer estimated for BAC, WFC, FIFT and C was $105 billion; this was later negotiated down to $54.3 under the now familiar arguments abouts earnings and the ability to sell stuff. This accomodation, which results in a reduction of required additional capital to the tune of 48%, dilutes the the integrity of the entire exercise.
It was either in Time or the WSJ that someone quoted as saying these reduction are reflective of the entire process, suggesting the exerecise was unterdtaken more to calm jittery markets than it was to really discover and repair the health of the nation's banking system.
Using Fed numbers from the stress test, we can under the adverse scenario, which is now the expected case, look forward to an additional $600 billion in bank losses through 2010. We can also expect banks to offset $362 billion of this number through earnings; this represents annual returns on risk weighted assets of 2.3%. BAC earned 2.2% in 2006 and 1.1% in 2007.
In addition to fudging the numbers to make everybody happy, we are essentially desiging a system wherein the banks can earn there way out of this mess. And in constructing the system, we probably have maximized the potential for bank earnings and, perhaps, understated likely losses.
TARP: Bailout or Money Pit? [View article]
Under both Bush and Obama, the TARP program has lacked clear goals, has been implemented in piece meal fashion and has suffered from lack of transparency. From the very beginning, the U.S. government made the mistake of addressing each major bank failure differently: aiding the takeover of Bear Sterns by JPMorgan, allowing Lehman Brothers to go bankrupt and then dumping $180 billion into AIG.
Under Geithner, there has been his underwhelming perfromance as a speaker and his inability to inspire confidence by communicating a thoughtful, comprehensive plan. Details of the stress test were slow to materialize and then there were the nagging questions of which capital ratios were to be used in guaging solvency. And there is the suggestion that purchases of preferred shares will be calibrated as losses occur.
Finally, when the government increased its stake in Citi to 36% and infused more capital into AIG, the markets took this to mean the problems are large, never ending and too big to be fixed. TARP has lost credibility with the market.