Part II | Stress Test Follies & Zombie Love

rcwhalen's picture

"Central bankers uphold one end of a grand bargain that has evolved over 350 years.  Democracies grant these secretive bureaucrats control over their nations’ economies; in exchange, they ask only for a stable currency and sustained prosperity (something that is easier said than achieved. Central bankers determine whether people can get jobs, whether their savings are secure, and ultimately, whether their national prospers or fails." 


"The Alchemists: Three Central
Bankers and a World on Fire"

By Neil Irwin

With the release of the latest Fed bank stress tests, we are once again left to ponder just on whose side really are the global central bankers.  This is further to our comment last week on the CCAR and the Fed stress test follies.

Once again, the Fed has deliberately chosen to understate risk from the housing sector, both in terms of haircuts on second lien exposures and reserves for legacy RMBS litigation and related exposures.

The Fed stress test is intended to “to evaluate whether a covered company has the capital, on a total consolidated basis, necessary to absorb losses and continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties, and continuing to serve as a credit intermediary under adverse economic and financial conditions.”  But somehow housing gets pushed down in terms of risk weighting.  

Our colleague Nom de Plumber is more than a little annoyed by the Fed.  In a private missive Friday, he exclaimed:

In these tests of bank capital adequacy under a severely adverse economic scenario,

the projected losses for second-lien residential mortgages and HELOC's would generally be less than 10% of principal balances.   (See Table 5 in CCAR report).  

That would be strangely lower than the actual default losses of first-lien Prime, Alt-A, and even some Agency mortgages during the current crisis.   

This odd result for a major asset category at "systemically important" banks might challenge the perceived validity and stringency of Federal Reserve stress modeling.   

Reliance upon these benign stress-tests may lull the regulators who built such models into a false sense of security.    

Back-loaded credit losses are ignored for front-loaded MTM stress, in current models.

Why should ex-ante AFS/HTM accounting treatment dampen subsequent stress losses? My example is that, if accounting treatment is relevant, we could have saved RBS, Bear Stearns, Lehman, and GSE's via HTM re-classifications. A Fed official noted accordingly my wonderment.

Thank you.

Then there was this missive from JB, who called the Fed stress test a charade:

I am surprised that nobody has picked up on the obvious, the fact that these tests truly had one purpose, and that was to present a facade as to the health of both Citi and BAC, this was a propaganda exercise, period.

Those two institutions continue to trade at fractions of book value due to the distrust of the marks on their books. This is fact. I believe the Fed made a concerted decision to change this and attempt to once again in effect bailout these institutions. I also believe that they are most at risk in the event of a downturn and a future taxpayer backed break-up/bailout.

Then there is Manal Mehta, owner of Interesting Finance Articles on Google:

"If BAC loses summary judgment motion on successor liability = $8.5 billion settlement on $108 of losses falls appart.  BAC's reserves will need to go up by at least $20-30bn. The Fed stress test assumptions are wrong."

Of course, “too big to fail” still lives in the hearts of fed officials.  Anyone who has perused the great Depression era studies of Fed Chairman Ben Bernanke knows that allowing large institutions to fail is bad.  Thus we have zombie banking institutions such as Citi and B of A wallowing in a sort of economic stasis, treading water and hoping that the crisis just goes away.  Between the subsidies flowing from the Fed to the banks and regulatory forbearance on asset quality issues, you could even make a case that QE is part of TBTF. Chew on that for a while. 

The downside of not restructuring is a lack of organic economic growth, in jobs and private enterprises.  The house one family loses in a short sale or foreclosure becomes an opportunity for another individual or family.  But between the new Basel III regulations and Dodd-Frank, the incentives for banks to lend against real estate have gone away.  The Fed’s stress tests may understate the true risk from existing real estate exposures, but they do nothing to change the strong disincentives for banks to write new real estate credit in the future.  

Maybe that’s why even with HPA up double digits in 2012, bank lending to the real estate complex was flat to down according to the FDIC.   Could it be that the risk of real estate finance has shifted to other market sectors, like C&I lending, private and public equities, and individual “Mom & Pop” investors?  You certainly won’t see the changing dynamics of mortgage finance under Basel III reflected anywhere in the 2013 Fed stress tests.  

Assume larger derivatives and consumer finance books, and a bigger haircut on second liens, and run the numbers again Mr. Chairman, with all due respect and our eternal thanks.  When you do that you’ll find that most of the top five banks are lighter on capital than the first round results would suggest.

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Jack Sheet's picture

"With the release of the latest Fed bank stress tests, we are once again left to ponder just on whose side really are the global central bankers."

If you still have to ponder that Mr Whalen, you are beyond help.

steveo77's picture

For sure, you could still win, but you are kind of late to the game for this free Platinum, you can enter up to March 23, and closest to spot price on March 29 wins the Platinum coin. 
But ONLY the first correct guess wins

Optimusprime's picture

" could even make a case that QE is part of TBTF"



123rainier's picture

thanks Otimusprime , just a simple plowboy but I thought that was obvious as well.

max2205's picture

Who trusts anyone's marks after 13 years of smoke up our asses

ebworthen's picture

TBTF = Too Big to Jail, as Eric Holder, head of the "Justice" (JustUs) Department admitted.

QE benefits the zombie banks, and does ZERO for employment and encourages further misallocation of capital while punishing savers and the responsible citizen.

No coincidence that the national debt, ballooning completely out of control, leads to talk of "austerity" and cuts to already taxed entitlements such as S.S. and Medicare.

The middle class is being bled to death, the rule-of-law is dead, and the FED is a treasonous cabal of banker lackeys.

Downtoolong's picture

you could even make a case that QE is part of TBTF.

Absolutely, no doubt of it.

TARP was nothing by comparison to the subsidies the Fed has doled out to the TBTF banks afterwards. Unless the Fed keeps up their pace, the banks will fail. Yet they all go around championing the fact that they paid back TARP with interest. What a bunch of tools.

When I accidentally painted the bedroom bright blue, I at least told my wife I was sorry and changed it to a color she liked. But, that still doesn’t make me an interior decorator now does it.


OutLookingIn's picture

TBTF is most certainly part of QE!

Just as TBTJ is part of TBTF!

According to Holder, "Can't jail, too big to fail!"

philipat's picture

How else could they offload their crap RMBS at 100 cents on the Dollar? Of course it's all part of the same circus.

....And don't call me Shirley.

ChanceIs's picture

Hmmmmm.  Hmm. The memory is a little fuzzy.  Oh yes.

"If the glove don't fit, you must acquit."


"If the stain's on the dress, you must confess."

So know...the stain is certainly on the banking dress......and the banking glove sure as hell fits......

Oh hell.  I never was good at rhyming.  I just wish that Holder would stop wearing out the knes of his AG pants, Jamie's carpet, save himslef some dry cleaning bills, and throw the little tadpole in jail.


stacking12321's picture

don't put it in quotes if it's not an exact quote.