FSA not going to publish stress-test data

The UK Financial Services Authority (FSA) is standing by its decision to not publish the results of the ‘stress-test’ it performed on UK banks. However, the FSA felt compelled to clarify the use of the tests. In a press release on May 28, 2009 it wrote:

The UK authorities have not applied stress testing in the same way as in the US – a single exercise covering simultaneously the top 19 banks which account for two thirds of the assets of the US banking system. Instead, over the last eight months since the intensification of the financial crisis, the Financial Services Authority (FSA) has:

  • Greatly increased the use of stress tests as an integral element of our ongoing supervisory approach.
  • Begun the process of embedding this revised approach in our intensive supervisory regime.
  • sed stress tests to inform policy decisions such as access to the Credit Guarantee Scheme (CGS) and the Asset Protection Scheme (APS) working closely with the other Tripartite authorities.

The FSA writes:

The stress tests used are not forecasts of what is likely to happen but deliberately designed to be severe. Their purpose is to consider whether an institution would be able to sustain adequate capital and liquidity under conditions which at the time the stress is conducted are considered unlikely to arise. They therefore aid our determination of whether firms are able to comply with our regulatory framework.
Stress testing is necessarily forward looking and therefore involves an element of judgement. This is particularly true given that the most important challenge facing the banking system has changed over the last six months.

and goes on to provide some details:

The current stress scenario models a recession more severe and more prolonged than those which the UK suffered in the 1980s and 1990s and therefore more severe than any other since the Second World War. It assumes a peak-to-trough fall in GDP of over 6%, with growth not returning until 2011 and only returning to trend growth rate in 2012. It models the impact of unemployment rising to just over 12% and, crucially, the impact of a 50% peak-to-trough fall in house prices and a 60% peak-to-trough fall in commercial property prices.

The FSA further points out that its efforts were supposed to fit into the EU-wide stress testing exercise to be performed on the aggregate banking system the CEBS coordinates, which Ireported on in an earlier post:

The UK approach to stress tests is similar to that followed in most countries, other than the US, which have applied stress tests to inform decisions on specific institutions and as part of intensified supervisory processes, rather than as a one-off, system wide and publicly disclosed process. CEBS has, however, now committed to co-ordinating a Europe-wide stress testing exercise to inform assessments of the aggregate health of the banking system. This exercise will use common approaches and scenarios and aims to increase the level of aggregate information available to policy makers in assessing the European financial system’s resilience to shocks.

One might conclude from this, that the national authorities in the EU consider it a problem of the banks to ensure that they are sufficiently capitalized and it is only the system as a whole who they need to be concerned with. However, we note that unlike the EU-wide test, which is not going to assess the health of individual institutions, the FSA has done just that.

I am still wondering how the CEBS wants to meassure the health of the EU financial system without relying on stress-test results of individual institutions.

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EU-wide Stress Test of Banks Planned

The EU wants to do its own stress testing of its banks and has asked the Committee of European Banking Supervisors (CEBS) to organize one,
story here.

According to a press release on the CEBS website, the test will take the following form:

12 May 2009
The Committee of European Banking Supervisors (CEBS) today publishes its statement on stress testing exercise.

– Supervisory authorities in the EU are, in the context of their regular risk assessment of the financial sector, carrying out an EU-wide forward looking stress testing exercise on the aggregate banking system.

– This is not a stress test to identify individual banks that may need recapitalization, as the assessment of specific institutions’ needs for recapitalization remains a responsibility of national authorities.

– This test builds on common scenarios and guidelines developed by the Committee of European Banking Supervisors (CEBS).

– The objective is an EU-wide exercise with common guidelines and scenarios, so as to increase the level of aggregate information among policy makers in assessing the European financial system’s potential resilience to shocks and to contribute to the convergence of best practices in the EU.

– CEBS’ next regular risk assessment will be ready by September 2009. The outcomes are confidential.

They don’t seem to be in a lot of hurry, nor do they seem to take this very seriously as their choice of words reveals. If that’s an exercise, how does the real thing look like?
Also the fact that not the individual institutions but the banking system as a whole (aggregate) will be tested doesn’t infuse one with much confidence either. Apart from the fact that we find it difficult to test the system without assessing the health of at least the most important institutions, i.e. the ones with the largest balance sheets,  we also think that the result should be shared and not be declared confidential. This would seem rather obvious if the goal would be to improve the confidence in the market.

This is supposed to increase investor confidence?

This is an interesting sequence of events.  On late Thursday, May 7 2009 the stress test results were released to the public. Never mind that the banks negotiated the results. In any case they already knew the results before long before others did, as is shown by Goldman Sachs confidently raising capital on April 14, 2009.

Morgan Stanley announced on Friday, May 8 2009 in a press release that it would raise $3.5 billion via a common stock  and $4 billion via a senior notes offering to the public. This will generate will generate some $7.5 billion in capital, minus some 0.35% of fees that Morgan Stanley pays to its agent, which is, well, Morgan Stanley.

In a second press release that same day, Morgan Stanley announced that it would exercise its over-allotment option and purchase an additional 21.9 million shares at $24.00 each. This, however, merely rearranges some items on the bank’s balance sheet. Since MS uses its own capital to exercise this greenshoe option, its not bringing in any additional capital.

Wells Fargo intends to raise $8.6 bln trough the issuing and sale of common stock as it announced also on May 8, 2009.

In both cases, Morgan Stanley and Wells Fargo, the underwriting process runs until May 13, 2009. Bank of America did not make an announcement yet. Obviously, they are in a lot of hurry to get people to buy their shares and debt.

Would anyone buy these shares, let alone the senior notes if not for the government attesting those institutions “good health”? The common shares is a sure loss, with the senior notes you at least have a chance of getting something back in case of a bankruptcy, even though the senior notes are not FDIC insured.

This article on Reuters points out that one reason the banks passed the stress test at all was the improving markets. Mark Felsenthal writes on May 9, 2009:

In early March, a month after Treasury Secretary Timothy Geithner announced the tests on February 10 to help restore investor confidence in the major banks, the scene was much bleaker: major stock indexes had slumped to 12-year lows on persistent fears about the financial weakness. It looked possible that a major bank might need an emergency government rescue even before the stress test results could be announced.

But since the trough, markets improved steadily with rising share prices and volumes, better liquidity and other signs of stabilization, and regulators gained comfort that capital markets would be willing to fill any holes the stress tests unearthed at banks.

“It looked to us by mid-March, and early April, that this might work,” said a senior U.S. regulatory official, who spoke on condition of anonymity because of the sensitivity of the tests.

This brings us back to Goldman Sachs and the Supplemental Liquidity Provider role it plays at the NYSE, doesn’t it. Well, what does one expect. Wall St. is a rigged game, so is the stress test, which was obviously long in the making and designed to make banks look good. After all how do you instill confidence but by claiming everything to be ok. We are now waiting for the ‘well-done’ bonuses to be doled out the senior management.

There is a lot of bad smell in this whole thing. It will be interesting to see where the market goes after May 13.

The results are in banks are doing fine-NOT!

The U.S. Treasury has published the results of the so called “stress test” of the 19 major banks. Surprise, surprise the picture is all positive. See the list at the Washington Post and at Zero Hedge.

So the banks are save, what now? Well, contrary to what they want to make us believe, banks maz not be as save as they now appear to be. The results of these so-called stress tests are unreliable for several reasons.

The stress tests were not thorough and relied mainly on the banks view of their own assets quality. As mentioned in the Feds press release

More than 150 examiners, supervisors and economists from the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation participated in this supervisory process. Starting from two economic scenarios–a consensus estimate of private-sector forecasters and an economic situation more severe than is generally anticipated–they developed a range of loss estimates and conducted an in-depth review of the banks’ lending portfolios, investment portfolios and trading-related exposures, and revenue opportunities. In doing so, they examined bank data and loss projections, compared loss projections across firms, and developed independent benchmarks against which to evaluate the banks’ estimates. From this analysis, supervisors determined the capital buffer needed to ensure that the firms would remain appropriately capitalized at the end of 2010 if the economy proves weaker than expected.

What the Fed is telling us here is that it has “more than” 150 – probably 151, or do they not even know how many people worked on this? – examiners, supervisors etc worked on it. This is not many considering that they had to stress test the 19 largest banks. Thankfully, they could rely on the banks data and just rubber stamp the results the banks required.  As pointed out by Barry Ritholz

the Consensus estimates, professional forecasters and blue chip surveys have all been awful — terribly wrong — during this entire fiasco.

Why then should anyone assume that they are right this time?

That the results were not scientific but negotiated is fully clear from an article in the Washington Post writes

The banks were intent on sending a message that they were strong enough to weather the economic storm and didn’t need additional capital infusions from the government that could all but nationalize their franchises.

I fail to see the value of a test in which you can not only define the contents of the tests, the weight of the questions being answered and negotiate the result.

Paul Krugman in his New York Times op-ed of today writes that

As a result, the odds are that the financial system won’t function normally until the crucial players get much stronger financially than they are now. Yet the Obama administration has decided not to do anything dramatic to recapitalize the banks.

I am wondering, if the taxpayer will be liable if the banks tank again. After all, the government has given an investment advice. If someone follows that, loses money and it turns out the government whitewashed the banks, this could be expensive.