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February 26, 2014

Banks strive to weather the Fed’s stress test storms

“While examining bank balance sheets during recent stress tests, Federal Reserve officials became suspicious.”

“They found too many assets that would have performed very well in 2008 but that had no reason to be there now. Credit default swaps on mortgage bonds, for example. These hedging instruments were among the best performing assets during the crisis, as the cost of insurance against an imploding housing market skyrocketed.”

“However, the officials concluded that the assets were being held now not to produce profits in the real world, but to produce profits in their tests.”

“Since they were first deployed in 2009, the US stress tests have been cheered by investors for rebuilding confidence in a sector once deemed rotten to the core.”

“Under the tests, the Fed subjects each institution to a variety of scenarios, from macroeconomic events such as a spike in unemployment to market shocks such as the collapse of a significant counterparty.”

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Read full Financial Times article here.

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