The outworkings of the US banking stress tests are nigh, and they don't sound like good news at all. Another huge round of recapitalisation seems to be looming.
This is hardly surprising. With the suspension of marking-to-market the banks were given an easy time and have been hiding behind a dense smokescreen for many months. Obviously, firms that went for so long without modelling (or at least, without disclosing) their exposure to systemic risks were not going to be in a hurry to volunteer such analyses.
But now they've been forced to do it, and even under the relatively benign 'stress' that's been applied, they are revealed as badly under-capitalised. Benign stress ? Well, all the US authorities have required is input assumptions for a base-case of:
a 2.0% GDP decline in 2009 and a 2.1% GDP gain in 2010, unemployment reaching 8.4% in 2009 and 8.8% in 2010, and house prices falling 14% in 2009 and 4% in 2010
and a “severe-but-plausible” case:
a 3.3% GDP decline in 2009 and 0.5% GDP gain in 2010, unemployment at 8.9% in 2009 and 10.3% in 2010 and house prices down 22% in 2009 and 7% in 2010
Sorry, that's not severe; and the base-case isn't a stress test at all, it's the expected case. As we wrote here 18 months ago, one of the problems of stress-testing
"... is paucity of imagination: the worst we can envisage is what has happened before. When oil was last at $10 (1998!), very few companies were stress-testing for $80. When Enron was the pre-eminent market-maker for every wholesale energy player, few were considering its sudden melt-down: who is modeling the collapse of a really big bank now?"
That was 11 months before the Lehman collapse (and 9 months before $147 oil !) You've to try a lot harder than an 0.5% GDP gain, for pity's sake, to provide a genuinely illuminating extreme.
In the first instance, it seems, the banks will appeal the results: just as in the UK (recall our comment on the hints in Turner's Review), banks in the US apparently negotiate their capital adequacy. Then, they'll be out trying to raise vast sums of additional capital. And all against what can only be described as sanguine stress-testing.
There can be many a lull in the storm, many a bear rally in the downward trend. We've just been having one. It may be coming to an end.