International Forecaster Weekly

Bank Stress Test Not Based Upon Reality

What do you believe the Fed can do? Biggest banks in a stress test, leaking secrets, a little spring fever could take us into the summer, cash strapped California waits for Facebook IPO, Fed not taking everything into consideration when measuring the economy.

Bob Chapman | March 21, 2012

If you buy the Fed’s view of what is likely to constitute stress, there is some justification for its action.

Even then, you should ask the question that Anat Admati, a Stanford University finance professor, has been pressing: Why would we let banks reduce their capital in the face of so much financial and economic uncertainty around the world? If you leave shareholder equity on bank balance sheets, it still belongs to shareholders. Let it stay there as loss-absorbing capital in case the world turns nasty again. 

Reducing bank capital, according to Admati and her colleagues, doesn’t help the economy. Bankers like lower capital levels because their pay is based on return-on-capital unadjusted for risk. Shareholders are willing to go along either because they don’t understand the risks of thinly capitalized and therefore highly leveraged businesses, or they expect to share in the downside protection that will be provided by the government…

Make no mistake: Lower equity at big banks means higher expected losses for taxpayers down the road. Don’t let anyone fool you into thinking that banking crises are costless…

As chief economist at the International Monetary Fundin 2007 and 2008, I sat through innumerable meetings in which the senior Fed official painted a picture of the world that, in retrospect, was overly optimistic. When the Fed ran stress tests in early 2009, did it anticipate the depth and length of the U.S. recession? When it ran tests in late 2010, did it envisage even the rough contours of what became the European sovereign debt crisis? In both cases, the answer is no -- neither the Fed nor anyone else knows the future…My sources tell me that the Fed further assumed that only one large European bank would fail. But a single failure is a rarity…Another major omission from the stress tests is any serious consideration of interest-rate volatility, either with the economy far below full employment…or if there is a faster than expected recovery.

The Federal Reserve Bank said on Friday it had made mistakes in calculating bank losses in stress test results released this week. In revised figures released on Friday, the Fed reduced Citi's losses on first lien mortgages from $9.3 billion to $8.9 billion under the stressed scenario. The change occurred after the Fed decided to remove foreign mortgages from that calculation…

Their purpose wasn’t to test whether the nation’s biggest banks could survive a financial blowup like that of 2008 without government assistance.

Rather, the Fed designed its tests to measure the effects a hypothetical crisis would have on banks’ regulatory capital. Capital is the financial cushion a company has available to absorb future losses.

While the Fed would like for us to believe that regulatory capital is the same thing, it’s quite different.

And too often it bears little resemblance to reality. That’s why the results of the Fed’s “comprehensive capital analysis” are more about public relations and manufacturing confidence than they are about disseminating reliable information on banks’ health…

The Fed’s analysis, by contrast, didn’t take changes in liquidity or market conditions into account when estimating the future losses on banks’ loans or securities, except where the companies were using fair-value measurements for such assets already.

A person at Goldman Sachs Group Inc, who has not been identified or charged in a broad U.S. insidertrading probe, was caught on a wiretap leaking secrets about Intel Corp and Apple Inc, a lawyer for former Goldman board member Rajat Gupta said in court on Friday.

In a letter he (Brodsky) said the government had a person who provided confidential information to Raj Rajaratnam about Apple and Intel, Naftalis said. "There is also wiretap evidence, substantial evidence of another source at Goldman Sachs." Naftalis told U.S. District Judge Jed Rakoff that the defense believed "there is a much more circumstantial case that person should be sitting in the box rather than us and the wrong man is on trial here.

Gallup on the Fed Employment Report: …a comparison of February's household survey results to the government's December 2011 unadjusted unemployment data suggests a much more modest improvement in jobs and the U.S. economy over the past two months. The number of employed Americans increased by 3,000 on an unadjusted basis between February 2012 (140.684 million) and December 2011 (140.681 million). On the same basis, the number of unemployed Americans increased by 738,000 to 13.430 million in February 2012 from 12.692 million in December 2011….


Bob Chapman - liberty Round Table - 19 March 2012


Bob Chapman - The Fnancial Survival - 19 March 2012


Bob Chapman - USAPrepares - 20 March 2012


John Williams: Nonetheless, the Bureau of Labor Statistics (BLS) was somewhat shy in tabulating the February jump in unadjusted gasoline prices (4.9% versus 5.8% as reported by the Department of Energy), which, combined with unusually soft seasonal adjustments to gas prices, left the headline CPI-U monthly inflation at 0.4%, instead of what would have been at least 0.5% otherwise…

Gasoline Price Inflation Was Understated in the February CPI. Per better-quality reporting out of the Department of Energy (DOE), unadjusted gasoline prices rose by more than was reported by the Bureau of Labor Statistics (BLS) in the February CPI. Separately, for the third straight month, irregular seasonal adjustment patterns also muted adjusted gasoline-price inflation as well as aggregate adjusted CPI- reporting. The nature of CPI seasonal adjustments, however, is that they get revised only once per year, instead of every month as is done in the concurrent seasonal adjustments of payroll employment and retail sales. Accordingly, whatever is short-changed by the CPI seasonals in one month should be restored fully in a later month.


Call it spring fever. For the third year in a row, optimism is spreading that growth in the United States could be poised to accelerate and drive the economy into sunnier pastures

But bursts of optimism have sown false hope before.  This time last year, the U.S. economy was adding jobs at a similar pace of more than 200,000 a month between February and April. Growth was nipped in the bud by the Arab uprising, which sent oil prices soaring, and took another blow when Japan's massive earthquake disrupted the global manufacturing chain. First-quarter output in 2011 was a paltry 0.4 percent and 1.7 percent in the second quarter…  [How often do we have to cite seasonal adjusting?]


Felix Salmon: From 1970 through the beginning of the crisis in 2008, GDP grew at a pretty steady pace.

But the amount of debt required to generate that output just got bigger and bigger  the rate of growth of the credit market was much faster than the rate of growth of GDP. In 1970, GDP was $1 trillion while the credit market was $1.6 trillion: a ratio of 1.6 to 1. By 2000, when GDP reached $10 trillion, the credit market had grown to $28.1 trillion: a ratio of 2.8 to 1. And by mid-2008, when GDP was $14.4 trillion, the credit market was $53.6 trillion. That’s a ratio of 3.7 to 1. In other words, in order to keep up a steady rate of GDP growth, we had to saddle ourselves with ever more cheap and dangerous debt…


The riskiness of securities backed by assets from car loans to commercial mortgages is rising from the lows seen after Lehman Brothers Holdings Inc.’s 2008 collapse, according to Moody’s… Easing underwriting standards and ‘untested’ issuers and assets are contributing to the trend, along with structural features of transactions that can boost risk… Greater dangers are likely to follow, analysts Claire Robinson and Joseph Snailer wrote.


CNBC’s best reporter, Diana Olick: Did Warm Winter Steal Spring Housing? 

Home builder sentiment, as measured by the National Association of Home Builders’ monthly sentiment survey, was unchanged in March, and February’s reading was revised down. This after five straight months of gains in builder confidence. 

“Many of our members continue to cite obstacles on the road to recovery, including persistently tight builder and buyer credit and the ongoing inventory of distressed properties in some markets, said NAHB chief economist David Crowe in a release. Most troubling was a big drop in sentiment out West, which is where the bulk of the nation’s foreclosures and distressed properties are.

With temperatures in most of the country hitting near record highs in January and February, it begs the question, did much of the Spring market start early, and did it steal from the historically strong months of March and April? “We think it has pulled forward a useful amount,” says analyst Stephen East of ISI Group…


Long a harbinger of national trends and an incubator of innovation, cash-strapped California eagerly awaits a temporary revenue surge from Facebook IPO stock options and capital gains. Meanwhile, Stockton may soon become the state’s largest city to go bust. Call it the agony and ecstasy of contemporary California.  California's rising standards of living and outstanding public schools and universities once attracted millions seeking upward economic mobility. But then something went radically wrong as California legislatures and governors built a welfare state on high tax rates, liberal entitlement benefits, and excessive regulation. The results, though predictable, are nonetheless striking. From the mid-1980s to 2005, California's population grew by 10 million, while Medicaid recipients soared by seven million; tax filers paying income taxes rose by just 150,000; and the prison population swelled by 115,000.  California's economy, which used to outperform the rest of the country, now substantially underperforms. The unemployment rate, at 10.9%, is higher than every other state except Nevada and Rhode Island. With 12% of America's population, California has one third of the nation’s welfare recipients.


Connie Wang paid about $960,000 last June for a new four-bedroom, four-bath house in a sprawling swath of Southern California that’s home to Disneyland and Pimco. Now she may buy a second as an investment.  ‘You know why Orange County is doing better?’ said Wang, a native of Taiwan who splits her time between Shenzhen in southern China, where she oversees a toy-manufacturing business, and Irvine, California, where she raised her three children.  ‘It’s because all my neighbors are from China and Taiwan, and they all bought their homes in cash.


New Jersey’s state and local governments may need to cut services by 20% to close growing budget deficits over the next five years, a panel that includes former top-level state officials said… The state will confront gaps between revenue and spending of as much as $8.1 billion by 2017, while towns and cities may face shortfalls as great as $2.8 billion, said the group, which was convened by the Council of New Jersey Grantmakers. Counties’ budget gaps may be as much as $1.1 billion while schools’ deficits will reach nearly $1 billion, the group said.


            Homebuilder sentiment was unchanged in March to hold at the highest level since June 2007, while sentiment in February was revised lower, the National Association of Home Builders said on Monday.

            The NAHB/Wells Fargo Housing Market index held steady at 28, the group said in a statement, shy of economists' expectations for 30.

February's reading was revised down to 28 from 29.