Stress Test

The market took one look at the stress test results... sniffed around the latest bail out plans (after taking 15 minutes to download the stress test pdf from a server capable of handling at most 5 simultaneous requests)... and slammed the 2 Year to the lows of the day. Good news though, it is not at 10% yet. Give it 12 hours.

And so the Irish bank sector is about to nationalized.

• IRISH REGULATOR SAYS FOUR BANKS NEED EU24 BLN MORE CAPITAL
• BANK OF IRELAND NEEDS TO RAISE 5.2B EUROS OF NEW CAPITAL
• IRISH LIFE NEEDS TO RAISE 4 BILLION EUROS, CENTRAL BANK SAYS
• EBS NEEDS TO RAISE EU1.5   BLN IN CAPITAL, REGULATOR SAYS
• ALLIED IRISH BANKS NEEDS TO RAISE EU13.3 BLN IN CAPITAL

In 15 minutes it is possible that we will get the first guest of wind to topple the European house of insolvent banking cards, just in time for the pro forma cruelest month to upshift into the real one. Readers can watch the Live press conference: "Publication of Capital and Liquidity Results by the Central Bank of Ireland" at the link below.

It is no secret that everyone who manages money looks at each and every iteration of the European (or US) stress tests as nothing but a glorified farce, attempting to restore systemic credibility, yet which ulitmately always end up hurting it. That the first European stress test identified exactly zero of the banks that failed within months in Ireland is also no secret. However, with Europe once again out of options, here comes stress test round two. For those who care about this grand farcade (sic), here is a simple visual summary. We fully intend to recreate this post some time in March 2012, describing what Stress Test round 3 will look like.

One would think that the S&P doubling from the March 2009 lows would be indicative of a mission accomplished for the Fed's market manipulation, aka Open Market Operations, team. No such luck. In fact, while the abominable Dr Chairsatan and Messrs Frost Sack are spouting garbage about economic recovery to anyone retarded enough to listen (oddly they have found a great audience in Congress) behind the scenes they are telling banks to prepare for a stress test recession scenario in which unemployment is 11%. And since current unemployment is about 23%, and we continue to be in a Depression, we assume this means that the Fed is actively preparing to make sure banks will be able to handle the explosion in economic growth and, oh yeah, hyperinflation, when the $1.7 trillion in excess reserves as of June 2011, finally flood the market. Although since this statement may be sufficient to get Zero Hedge to issue "unsolicited" opinions on the state of the Great Ponzi, we will go with the party line here... Which we find confusing: why would the Fed force US banks to undergo another stress test: aren't they all massively overcapitalized? Wasn't that the whole point of the first fraud of a stress test back in 2009 which had he same credibility as the upcoming European one? And why not cut to the chase and conduct a Ponzi unwind stress test? So many questions...So many more lies.

When two weeks ago we highlighted the news that key title insurers such as Fidelity National are demanding indemnity and warranty from banks, we asked "what happens if the bank is once again caught to be, gulp, lying?
Who foots the bill then? Why the buyer of course. All this does is to
remove the liability from companies like Fidelity National and puts it
back to BofA, which is already so much underwater it has no chance of
really getting out without TARP, contrarian Goldman propaganda
notwithstanding." And while our speculation provided amusement to some of the more (vastly so) polemic elements in the blogosphere, it appears that Alan Grayson took this development seriously, and sent a letter to Geithner demand that a special capital buffer be established at the TBTFs, to absorb any and all losses that will arise from foreclosuregate (especially since earlier today it was made clear that certain banks such as First Horizon don't have any provision for putbacks). In Grayson's words: "Recently, Bank of America struck a deal with Fidelity National Title Insurance to indemnify the title insurer should legal problems with foreclosures create unanticipated title liability.  Title insurers are clearly worried that they may face higher legal and policy costs if foreclosures are reversed, or should legal ambiguity cloud titles they already have insured...Since title insurers have in some cases just refused to insure this market, someone must pay for the liability these insurers have refused to incur. Both banks and regulators are claiming that the problems are simply process-oriented document errors that aren't really causing harm to the public at large.  I suspect that no one really knows the extent of the problem, or the potential liability.With that in mind, it would seem prudent to require additional capital buffers for systemically significant institutions until the extent of the foreclosure fraud crisis is understood." We wholeheartedly agree with Grayson.

Remember when the pathetic farce that was the stress test presumably prevented Europe's collapse, and served as the inflection point preventing the EUR from hitting parity with the USD? Well, one of the banks that the "stress test" uncovered to be solvent was the recently insolvent Allied Irish Bank, which earlier this month needed a taxpayer injection of billions to presumably make sure that European creditors (and likely Goldman Sachs, very much like the case in Anglo Irish) never see even one dime lost. And today, an Irish Member of the European Parliament Alan Kelly said he intends to write to the EU Competition Commissioner to discover just how it is that one of Ireland's top banks slipped through the stress test cracks only to require a bail out mere months later. It appears that slowly everyone in Europe is starting to turn against the trillions in German bank liabilities that stand to be impaired, and lead to a systemic collapse, unless local taxpayers dutifully reach into their back pocket and make sure fat bankers continue their worry-free existence.

Now this is what a real stress test should look like. Bloomberg quotes a banking insider that "China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets." And just in case it is unclear what the reality of the situation is, because as Europe demonstrated all too well, nobody would test for something which is not already priced in, China is effectively telegraphing to the world that it is bracing itself for a more than 50% plunge in select real estate values. "Banks were instructed to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent." The doubling in stress is somewhat to be expected considering the tens of trillions in renminbi pumped into the banking system via whole loans and other CDO products, most of which have gone into building up empty cities, vacant apartment complexes, and unused infrastructure projects. As we noted previously when discussing the recent Fitch report on shadow funding of the real estate bubble, the nearly 50 million in vacant units, the ugly truth about the Chinese bubble is slowly starting to leak out.

With the assumptions and conditions for the stress test pulled straight out of CEBS' collective bottom, it is no surprise that a mere 7 banks for a total $246 billion in affected assets end up being defined as undercapitalized. But what happens when instead of using a 6% Tier 1 capital threshold, a Basel III 8% Tier 1 is used? Something log scale worse. As Austrian Der Standart journalist Lukas Sustala points out, and as demonstrated on his chart below, the failure rate goes up exponentially: instead of 7 banks failing, 39 of Europe's biggest banks would be undercapitalized, and the impaired assets would amount to a whopping E2.6 trillion, requiring at least E30 billion in incremental equity capital, on top of the hundreds of billions already infused by European governments. In Lukas' words: "The stress tests were a farce (taking no account of counterparty risk or a sovereign default), but at least they provide some good data points (I currently look into all the sovereign holdings of the individual banks, so there is more to come). 39 banks fail the 8% criteria."

Earlier, we reported the Euribor jumped in response to a stress test than now is perceived as fraud by virtually everyone. We also expected some moderate reconfirmation in the Libor market. Sure enough, the last nail in the coffin of Eurozone credibility came from the 3 month Libor, which spike by 0.2 basis points to 0.82313%, the highest since August 21, 2009. Interbank lending in Europe just give JC Trichet and the rest of the propaganda goon squad the middle finger. All else is smoke and mirrors. And since the overnight index swap (OIS) rate dropped marginally, the LIBOR-OIS spread jumped by 0.538 bps to 26 basis points.

On a day (and week) when every European TV station is and will be blaring how safe Europe once again is because the Rock said so, and to ignore the liquidity bogeyman in the closet, the market has once again spoken. The result: benchmark 3 Month Euribor is wider at 0.889% versus 0.885% previously. We will bring you 3 Month European Libor as soon as we get it: somehow we doubt a massive contraction in those particular rates either. All those expecting that the European liquidity market would unlock overnight with the farce finally over, are in for a disappointment. And unlike their US equivalents, which trade on nothing but machine language momentum, European stocks, on a day when European banks passed their dodecatuple secret probation with flying colors, are flat to down. Looks like even an perfectly inefficient market wont fall for the same Geithneresque ruse twice in a row.

Hot on the heels of our earlier disclosure that the Landesbank stress test passage is either a joke or a scam, comes the knowledge that 6 out of the 14 tested German banks, including Landesbanks, have decide against posting their stress test details, specifically withholding the breakdown of their sovereign debt holdings. "Every other European bank, bar Greece’s ATEbank, which failed the test, complied with the disclosure requirement. Analysts said the German banks’ non-compliance would fuel suspicion they had something to hide, and risked further undermining faith in the whole stress test exercise, already criticised for its benign scenarios." Um "further undermine"? Has it not been made abundantly clear that the entire stress test soap opera was merely a pretext for Liberty 33 and Johnny 5 to ramp the market for the last hour of trading on Friday? Are people still confused that whenever Tim Geithner "plans" something, be it for the US, for his own tax estate, or for another continent, scammery, corruption and opacity are pretty much a necessary and sufficient condition for any "swiss watch" plan's execution.

Also Europe finds that :

• Full GoM clean up will be around 2 bucks
• The cost of the Large Hadron Collider was reduced to a couple of dimes
• The US budget "deficit" is estimated to actually be a $100 quadrillion budget surplus
• Merrill's expense tab at Hustler Club is only $19.95
• etc.

The circus in Europe can't come to an end soon enough. As Zero Hedge posted and speculated previously, according to a draft document, it has now been confirmed that banks will only be tested for sovereign debt exposure just on trading books, not on debt held to maturity. Guess what: about a month ago, all banks almost certainly decided to quietly reclassify their hundreds of billions of sovereign exposure from "trading" to "held to maturity," thus taking advantage of the same FASB 157 accounting abortion that America has gripped tightly on to for almost two years now, as accounting fraud follows the Bernanke Put in going global. If this is supposed to inspire confidence, then the market has truly lost it. As we explained last week, "the haircut will only pertain to
trading books. In other words this is Europe's equivalent of FASB 157:
everything that banks hold "to maturity" will not see a major haircut,
and very likely not see any haircut at all. Which simply means that all
European banks that hold such debt will merely reclassify their Greek
exposure from trading to a "held to bankruptcy at par" category. The
surreality of European banking assets (which as we pointed out
previously is a $100 trillion circle jerk where one bank's assets are another bank's liabilities) has now passed well into the twilight zone." In other completely irrelevant news, the micro trading books will see the following haircuts, as presented by Bloomberg.

RANsquawk European Morning Briefing - Stocks, Bonds, FX -- 23/07/10 (Stress Test Special)