The Bank Stress Test Was A Take Home Exam

Do you think the bank stress tests were all for show, and the eventual winners and losers have already been determined? Sort of like WWF wrestling matches?

From Zero Hedge:

(1) “more than 150 senior supervisors, on-site examiners, analysts and economists” spent a month reviewing the 19 BHC’s that hold two thirds of the country’s bank assets and account for one half of the loans

More than 150 means at least 151. Is the US Iceland or something? Ten trillion dollars in assets and five hundred trillion dollars in derivatives in one month? A typical single bank examination utilizes hundreds of examiners and takes several months. Clearly the next release of public sector productivity numbers is going to astonish.

That's less than 10 per bank--EPJ


(2) ”the firms were asked to project…..the firms were asked to provide…etc.”In other words, the banks tested themselves and the 150 examiners took their word for it. Any wonder they passed?...

“Supervisors evaluated firm loss estimates using a Monte Carlo simulation that projected a distribution of losses by examining potential dispersion around central probabilities of default.”

Ah…smells like Gaussian distributions. The old standard. We have seen how well that assumption works in these unusual times. An example of the dependability of using Gauss, taken from stock market movements in October, and calculated by Nassim Nicholas Taleb of Black Swan fame, showed that the price movements seen in October 2008 could be expected to occur---using estimates based on Gaussian distributions---once every 73,000,000,000,000,000,000,000 years.

For those of you not tied to Biblical strict constructionism, the Universe is around 18,500,000,000 years old. Looks like it will be a few quintillion years before we see October again...

Take a good look at just how complex and thorough this “test” was. An online dating questionnaire is more probing.

The Bank Stress Test
(Note this template is in the appendix to the Fed Report (pdf))

The SCAP Templates

Loan and Security Categories to be included in the Loss Estimates*
(Loss Amounts in Billions of Dollars)
Outstanding Balance

Q4 2008
Loss Estimates
2009
2010
TOTAL

LOANS
First Lien Mortgages
Prime
Alt‐A
Subprime
Second/Junior Lien Mortgages
Closed‐end Junior Liens
HELOCs
C&I Loans
CRE Loans
Construction
Multifamily
Nonfarm, Non‐residential
Credit Cards
Other Consumer
Other Loans

COMMITMENTS AND CONTINGENT OBLIGATIONS

List by type the amount and assumed losses related to commitment draw‐downs and other contingent obligations

SECURITIES

Available for Sale
Held to Maturity

TRADING ACCOUNT (including traded loans)

For the more adverse scenario only: report total dollar loss amount, table identifying positions captured and those not captured in the stress tests, risk factors stressed, and size of risk factor changes assumed.

* Form to be completed once for the baseline scenario and once for the more adverse scenario. If there are positions, businesses or risk exposures not captured on this template that would materially affect losses under the baseline or more adverse scenario, please include estimates of those losses in addition to the losses associated with the positions included on this template.

Resources to Absorb Losses*
(Amounts in Billions of Dollars)
2009
2010
TOTAL

PRE‐PROVISION NET REVENUE
Net Interest Income
Non‐interest Income
Non‐interest Expense

ALLOWANCE FOR LOAN LOSSES
(1) ALLL at end of previous year
(2) ALLL at end of year
ALLL Resources: (1) – (2)
* Form to be completed once for the baseline scenario and once for the more adverse scenario.

Post‐Scenario Tier 1 Capital*
(Amounts in Billions of Dollars, end of period)
Q4 2008
2009
2010

Tier 1 Capital

Sum of Tier 1 Elements

Common Stockholders’ Equity
Risk‐Weighted Assets
* Form to be completed once for the baseline scenario and once for the more adverse scenario.