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August 9, 2011

No-stress stress tests?

As everyone speculates whether the 634 point drop in the Dow yesterday (Monday, August 8) will continue, stop, usher in a double dip recession, be forgotten in a week, unleash a bear or a bull market, or whatever, someone should look back at the so-called “stress tests” both the US and European governments did on their banks recently.  Back when there was little disclosure of the components of the stress tests and all the banks passed with flying colors, there was some talk of no-stress stress tests, where the supposed stress was pretty modest and really designed to make sure as many banks passed in a way that didn’t require them to do anything extraordinary like raise lots and lots of capital – which is what happened.  

Now, in the face of a global stock sell off, there are rumors and reports that numerous banks are in precarious shape.  (See the front page of the Wall Street Journal)

This puts a lie to the stress tests.  How could they possibly be valid or stressful if the very first stock market drop is so significant that it pushes them to the edge?  Remember, so far, this is just a stock sell off.  It isn’t even in bear market territory yet.  

Regulators have to stop doing tests that are designed for banks to pass.  This destroys whatever credibility they have left and it does nothing for the credibility of the banks or the markets.  Frankly, it’s lose, lose, lose, as everyone knows the regulators strategy is to spin and pretend, all in the hope that nothing bad happens, that the economy starts growing again, and that the banks’ write-offs won’t exceed their income.  This is irresponsible and simply wrong.  

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