Stress Test Plan is a Jumbled Mess

Posted by Michael A. Kamperman on April 20, 2009

It was and remains a good idea to stress test the banks.  It is important to know just what kind of shape each of the large systemically important institutions is in.  We already know the assumptions Treasury is using for what the base case is and what the worst case could be are far too rosy.  And frankly I do not trust the mathematical models they are using to show just what future credit losses will be.  Capital One has reported that the historical ratio of losses between the unemployment rate and credit card charge-offs seems to be breaking to the downside.  What other credit losses may break to the downside that is not factored in the models?  None of these mathematical models were designed for the debt induced deflationary depression we are now in.  Critically, the models do not have the real world facts that access to credit is far tighter than it has been since the Great Depression.  What impact will it have on credit losses when those with debts coming due have no way to roll those debts over?

The more serious issue to me is the comedy of errors that is brewing over the release of the stress test data and what to do about it.  Why did Treasury announce a plan to stress test the banks if they didn’t know what their end game would be?  For example, how could the plan possibly be that those financial institutions that need more capital will have 6 months to raise the capital in the private markets?  No one will invest in a financial institution the government claims is under-capitalized based on a rosy stress test.  How is it the Treasury doesn’t even know what information it will release about the stress tests?  This only raises more questions then it answers. 

It appears Treasury may not have a clear understanding of the depth of the problems the economy has and the solutions necessary to fix the credit markets.  Or, equally troubling is the possibility Treasury does understand the depth of the problem but it believes the political will to implement the necessary solutions does not exist in Washington.  Neither of these possible outcomes is comforting to me.  I hope I’m wrong and Treasury knows what the problems are, knows how to fix them, and can gain the political support it needs to implement its plans.  Heaven help us if my concerns are justified.

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