Wednesday 29 April 2009

Start of a New Downward Phase ? The Stress Tests Are In

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.



Simon Fawthrop said...

The obviously haven't even heard of Blck Swan let alone read it. Scary.

Bill Quango MP said...

Been a terrible two weeks here.

Mrs Quango's sister, an ex senior graphic designer, applied for a job helping children paint ceramics.
A real low tech job for a skilled worker. About £6k P/Time.

There were 62 applicants.
The next person who says 'green shoots' is fired.

Steven_L said...

Hmmm, on your previous track record Nick I could well believe that we are about to enter the next bad news cycle.

Thing is, so much bad news has been priced into everything that the markets are starting to react funny to news.

Look at the headlines on Bloomberg now:

"Stocks in U.S. Advance as DreamWorks, Time Warner Earnings Beat Estimates"

"U.S. Economy Shrinks More Than Forecast in Worst Recession in Half Century"

"Fed Finds at Least Six of 19 Biggest U.S. Banks Need to Raise More Capital"

DOW up over 150 points.

Question is, just how long are you pre-empting the bad news cycle by and how 'bad' will the news be?

Mickanomics said...

I guess that if the news headlines don't include the word "Armageddon" then it must be considered good news.

Nick Drew said...

GS - indeed, and extremistan is a neat concept: though Fooled by Randomness, his earlier work, is MUCH better, IMHO

not me, I assure you Mr Qtiming is everything, n'est-ce pas, Steven ?

welcome, Mick & I think you're right

Anonymous said...

Bill - you can guess how relieved I am that my own personal recession predated the general one by some months allowing me get a new job before the rest of the market joined my business in the toilet. I feel for your sister... I know what its like.

Sebastian Weetabix said...

Well, I'm in the middle of a 3 week tour of the USA visiting customers... & it doesn't feel like armageddon is around the corner. Our sales have nudged up in march & april since bottoming in february - still crap year on year, but going in the right direction. Restaurants are full, as was the mall I visited at the weekend. Our defence/aerospace & medical business is doing ok, RFID is growing, as is photovoltaics; automotive & consumer electronics are desperately in the shit though, so we are still about 35% down YTD. All the customers I've been speaking to feel they are through the worst, but all expect some of their competitors to go to the wall over the next 12 months. US optimism, I must confess, is infectious. I begin to feel our business will make it, & even that I won't catch flu, despite having been in & out of Mexico last week.

I guess the moral of my tale is that we should let the market function. Well-run businesses will survive & bad ones will (or at least should) die. Why this does not appear to apply to banks is a mystery to me. Why not just guarantee deposits & leave it at that?

Edindie said...

After applying for lots of graduate level HR jobs (she only has 2 yrs experience) my girlfriend decided to apply for less well paid jobs too to tide her over as it was taking a while. She applied for a job working as an usher for Leeds theatre; she was one of 547 applicants for that job.
That’s pretty crazy.

Demetrius said...

I have a daily stress test, it is called getting out of bed. It is a lot more reliable than the banking tests, and I fall over less than they do.

Electro-Kevin said...

The fiscal stimulus both here and in the US is ultimately intended to restore faith in property values - therefore the toxic debt held by the banks comes good once people start to believe it is good. In Britain the nationalised banks come good too and the Government ends up sitting on a pile of assets instead of liabilities. Prime Minister Brown is not a fucked up loon in charge of the clattering train crewed by total wankers - he's a genius ! We're all going to be rich !!! RIIIIICH I tell yer !!!