By John Bougearel, author of Riding the Storm Out, one of the first books out on the unfolding economic crisis
A few thoughts: Stress tests have been done repeatedly throughout 2007-2008 by banks and economists. There stress test models consistently undershoot. All stress-test models failed to hold up in this environment. It is a function of the inputs, you put optimistic garbabe in, you get garbage out.
Economists and the financial community have an optimistic bias to all their modeling, so we are being screwed with this new non-sense about stress-testing banks. Noise like this is akin to more screeching of the blackboard by the powers that be to market observers such as ourselves.
The stock market is beginning to show nascent signs of recovering from Obama’s first 30 days in office. But let us not fool ourselves, we are coming out of this hole in a sideways manner. This is perfectly consistent with the sideways BS on Capitol Hill in resolving the financial crisis. The stock market did not decline -21% from its Jan 6 year high to this weeks Feb 23-24 low without good cause. Moreover, this fledgling recovery in equities this week is suspect. We will continue to monitor the health of this equity bounce in conjunction with the obfuscation and double-speak coming out of Washington and policymakers. The latest double-speak meant to confuse the Americans that Washington is doing something productive to unclog the financial system is this flurry of stress-tests they are going to run on 19 big and bad banks.
According to the Supervisory Capital Assessment Program FAQs, the Stress Tests will be completed “as soon as possible” but no later than the end of April. These stress-tests will cover baseline scenarios that are more than optimistic. For instance, the Fed’s baseline scenarios assume only an 8.4% unemployment rate in 2009, and the Fed’s “Alternative-More-Adverse” scenario assumes an 8.9% unemployment rate. Well how clumsy are these assumptions?
Market participants should note that in the 1st 14 months of this recession, the unemployment rate shot up 310 bps from 4.5% in November 2007 to 7.6% in January 2009. The unemployment rate has been jumping 30 to 40 bps a month for the last several months and there isn’t anything on the horizon to slow that trajectory of job losses in 2009, because most of the jobs being created by Obama’s stimulus package does not kick in until 2010.
So, more than likely, the UE rate will reach Bernanke’s “Alternative More Adverse” Scenario before the 1st half of 2009 draws to a close. Another thing market participants will want to note is that economic forecasters will not revise their outlooks down until evidence that can not be ignored happens to come along. And when it comes to “stress-testing” we must recognize that “alternative more adverse” is not equivalent for stress-testing for “worst-case scenarios.” True stress-testing of economic modeling would stress-test for worst-case scenarios. But, in fact this is not what is being done.
