Tweet me!From what I know of the government’s stress testing, the assumptions are too lenient but the methodology is approaching just right. Their assumptions regarding unemployment have already been surpassed, thus is obviously too optimistic, but by bringing off balance sheet debt onto the balance sheet and recognizing the differences in underwriting quality in being just as important (if not more important) than the macro data, they are on the right track. This is probably why the banks are in such protest.
I think the majority of the banks are undercapitalized. Any institution that holds consumer deposits should be extremely low risk, hence sparsely leveraged – as should any institution that could pose a systemic threat. Thus size limits should be instituted for any banks that want to lever up. To take risk, you can’t get too big and you can’t carry consumer deposits – plain and simple. The easiest way to enforce this is to raise reserve requirements, ex. Force those institutions to raise capital or have them divest of their risk taking arms. Those arms aren’t even discernable until you bring off balance sheet assets and liabilities back onto the balance sheet. As you may very well be able to discern, the risks that the banks didn’t want anybody to see are those that they shoved away in special purpose off balance sheet vehicles. If you thought the stuff in plain sight was toxic, you ain't seen nuthin' yet. It is estimated that nearly a trillion US dollars are to come onto the bank’s balance sheets next year. What do you think the real value of those assets are as compared to the value that they are booked at? Subtract those two numbers, multiply the difference by the bank’s leverage factor (6x to 20x), and that is the amount you will have to slice off of the bank’s tangible common equity.
Now you see why the government is forcing the banks to raise capital against their will. Remember, most of these off balance sheet assets were bought/created with leverage using underlying assets that were in one of the biggest bubbles in the history of this country. The bubbles have popped. Just think about your buying Yahoo stock for $170 at the height of the dot.com bubble, using a super margin account that gave you 20x leverage (instead of the usual 2x leverage)… You would lose thousands of percent of any dollar you put into that trade if you look at Yahoo now. Or you could argue that mark to market is unfair because you are planning to hold on to the Yahoo stock until it goes back up to $170… Hint: Yahoo is trading at about $14 now.
If one didn't know any better, one would think that the UK regulators follow my blog:
Bankers Slammed for 'Astonishing' Financial Mess
