Bank stress tests?

[dsummoner]

Source:

The bank stress tests currently underway are “a complete sham,” says William Black, a former senior bank regulator and S&L prosecutor, and currently an Associate Professor of Economics and Law at the University of Missouri - Kansas City. “It’s a Potemkin model. Built to fool people.” Like many others, Black believes the “worst case scenario” used in the stress test don’t go far enough.

He detailed these and related concerns in a recent interview with Naked Capitalism. But Black, who was counsel to the Federal Home Loan Bank Board during the S&L Crisis, says the program's failings go way beyond such technical issues. “There is no real purpose [of the stress test] other than to fool us. To make us chumps,” Black says. Noting policymakers have long stated the problem is a lack of confidence, Black says Treasury Secretary Tim Geithner is now essentially saying: “’If we lie and they believe us, all will be well.’ It’s Orwellian."

[zenwalk]

This article points out the problem with all news these days. It tells you nothing. He said, he said... nothing about what a stress test is, why they are shams etc...just that they are.

[dsummoner]

From the link to the Naked Capitalism article.

You can't conduct a meaningful stress test without reviewing (sampling) the underlying loan files and it seems likely that the purchasers of securitized instruments (not just mortgages) do not even have the loan file data. Moreover, loss ratios vary enormously depending on the issuer, so even a bank that originates (or has purchased a bank that originates) similar product cannot simply take its own loss rate and extrapolate it to the measure the risk on the value of securitized credit instruments.

As Geithner describes the process, NO ONE can conduct reliable "stress testing." It inherently requires testing everything in every way any and all aspects of everything could conceivably interact. It also doesn't provide any meaningful output that can be operationalized (unless you want to force an enormous rise in minimum regulatory capital requirements, which he obviously doesn't want to do).

Examiners certainly can't A) do the stress testing that Geithner describes or B) evaluate the reliability of a large bank's proprietary stress test. If they were serious about constructing reliable stress tests, which they aren't, you'd require their analytics to be made public. You'd have the industry fund independent investigations by rocket scientists chosen by a committee selected by the regulators of the soundness of the analytics. You'd also have the industry fund competitions to rip them apart (a bit like we hire legit hackers to test security by trying to defeat it) and show where they produce absurd results. The geeks would have a field day (that would probably last a decade). There are probably zero examiners that have the modeling skills required to evaluate the most sophisticated stress test models. The concept that there are 100 examiners with these skills, suddenly freed up from all other duties, assigned to CONDUCT stress tests is a lie.

PDF file from the IMF regarding bank stress tests.

Danske Bank's stress test methodology.

[Evil Yoda]

The purpose of the stress test is to restore confidence. It doesn't matter whether it's real or not, if enough people believe it. The government is confident that if it tells people it knows what's going on with conviction, people will believe it. However, it's failures with food safety, drug safety and to discover Madoff despite being all but handed the man's perfidy clearly demonstrat that government does not know and perhaps never has known what is going on.

If you base confidence in the economy on government pronouncements you will probably be disappointed.

[Kemmer]

And if we all clap our hands, to show we believe, all the banks will live. Hey, it worked for Tinkerbell, right?

Y'know, if banks hadn't invented off-balance-sheet SIV's, and such, there would be no need for Big Brother to lie about stress tests. Amazing how just a bit of honest transparency could have prevented this whole mess.

[Lansdowne11]

Honest transparency works for the little investor and the consumer, but it inhibits banks. The stress tests and other government seals of confidence are meant to protect the banks, not the citizenry. Deposit insurance helps banks, not consumers. Yes, you'll get your money back, but the only way to get you to deposit in the first place is to know the government will bail you out if the bank goes belly up.

All of those government agencies formed to protect the consumer do very little other than make us believe our food, prescriptions, cars, money and whatever else are safe, but look closely at how any of them really go about protecting us, and you'll see it's slanted toward corporations, not us.

[mike]

Stress testing was controversial before the banks went bad. They are trying to put a global standard in place, which makes sense since money is flowing across borders like it or not. And they need common risk measurements, otherwise hot money will flow to where the risk/return is highest.

Basel-II has been under discussion since 2002ish...when many were questioning the need for stress testing since banks were super healthy "why do we even need deposit insurance when no bank has failed in....years".

Basel II/stress testing is not a govt thing. The govt is simply stating that everyone's going to do it, so no one can hide behind a 'we are strong, we dont need it' story, which makes others react with 'we dont need it either'. The idea is to increase transparency across all banks in all countries, not just the US.

Read the wiki. It was written well before the crash.