Stress Tests Are Stressing Everyone Out

Photo: Everett Bogue; Photos: Getty Images, istockphoto

So, these stress tests. The results of the administration's fun "Let's Run a Worst-case Scenario on Nineteen of the Largest Banks and Then Publish Them Because People Aren't Freaked Out Enough" experiment, which were due to be published today, have been pushed back to Thursday because some of the nineteen banks apparently need to raise a few billion more so as to avoid embarrassing everyone involved. (The government's not naming any names, but someone told the Financial Times that Bank of America and Citigroup are both scrambling to raise $10 billion each, and Wells Fargo has also been fingered as a potential loser.) The decision not to publish until the banks have made their balance sheets less embarrassing has stressed market watchers out even more, and raised a lot of questions about the stress tests' credibility, the government's motives and methodology, and whether the results will ultimately mean anything, anyway. Here's what some people are saying.

• "Ummm ... this should not be happening," says economist Brad DeLong of the delay. "The banks should not be negotiating with the government over this." [Grasping Reality with Both Hands]

• Yves Smith of Naked Capitalism concurs: "The fact that the authorities are allowing banks to negotiate the findings is a very very bad sign," he says. "It says either they don't trust the results themselves, or they lack the guts to act like they are in charge." [Naked Capitalism]

• Paul Krugman is worried about the leaks to the press. They seem like "trial balloons" being floated by the government, he says, which just "add to the bad feeling about all this ... as if the report’s contents may also be dictated by what, based on the response to leaks, the informed public is willing to swallow." [NYT]

• Dwight Cass at Breaking Views says that "the behind-the-scenes tug of war" between banks and the government "strains the already tenuous credibility of the exercise .... Like the banks’ earlier and insufficiently stressful stress tests, the government’s worst-case outlooks aren’t all that far-fetched. They also use banks’ own estimates, meaning unscrupulous managers could tweak them to get a better grade. And bankers say they’ll produce very little information that regulators don’t already have." [Breaking Views]

• James Kwak is empathetic to the government's "conundrum": "From a regulatory perspective, the goal is to determine which banks will fail a worst-case scenario and force them to take preventive action. But at the same time, the Treasury Department is trying to restore confidence in the financial system ... in the long term, rigorous stress tests that the public has confidence in should boost confidence by making clear that at least some banks are healthy, even if they reveal that some banks are sick. But in the short term, labeling specific banks as sick would effectively cause runs on those banks, putting them into immediate danger and possibly triggering ripple effects on other financial institutions .... This is an outcome that the Treasury desperately wants to avoid .... This week should be interesting." [Hearing/WP]

• Goldman Sachs economist Jan Hatzius told the Times that although he initially thought the stress tests "would not take a sufficiently dark view," he's coming around. "We are changing our mind about this," he wrote in a note to clients last week, because the tests now seem likely to assume loan-default rates higher than those of the Great Depression, and "putting together a plan for the financial system to withstand such losses 'would be a big step toward a resolution of the crisis.'" [NYT]

• Between handfuls of peanuts and sips of Dr Pepper, Warren Buffett argued at his annual shareholders meeting that regardless of the timing of the results, the tests were inherently flawed for another reason: Because they failed to account for strengths in lenders' business models. "You get the impression from reading it there will be percentage whacks (at various assets)," he said. "That is not a very sophisticated way of looking at it." He also said he'd put all his money into Wells Fargo. [Reuters]