Inside Financial Services

The Fed’s Bogus Stress “Tests”

These aren't objective assessments. They're something else, and very unhelpful.

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The most revealing result of the just-completed stress tests the big banks lately went through isn’t the size of the potential losses that might occur under the Fed’s “severely adverse” scenario, in my view, but rather the difference between the assumed losses the Fed came up with and the banks’ numbers. Have you seen them? According to the Fed, for instance Wells Fargo would take a $25.7 billion hit under its severely adverse conditions, while Wells Fargo itself, operating under the same set of assumptions, puts its hypothetical loss at just $1.7 billion. That’s a $24 billion difference. For JPMorgan Chase, the difference between its hypothetical losses and the Fed’s is $32 billion. For Goldman Sachs, $13.9 billion.

This is no way to regulate banks. The gaps between the two sets of numbers make it pretty clear that the stress tests aren’t “tests” in the way the word is commonly understood: a rigorous process of assessment. Rather, they appear to be a series of assumptions piled one upon the other, designed to produce the output the regulators want. An outside observer might be forgiven for thinking, for instance, that since JPMorgan Chase has been naughty over the past year (it jumped the gun in announcing last year’s results, remember, never mind the London Whale), it got a little CCAR-related spanking. Thus that $32 billion gap between its estimated losses and the Fed’s. Bank of America, meanwhile, has spent the past few years in the doghouse but lately seems to be getting on regulators’ good side. Surprise! There was just an $8 billion gap between its estimated losses and the Fed’s estimate.

This appears to be highly arbitrary regulation, and it doesn’t do anybody any good. Not the banks, who are forced to operate in an environment of heightened uncertainty at a time when they could use less of it. Not borrowers, who will find credit more expensive and less easy to get. And not voters and taxpayers, who’ll have to put up with slower economic growth thanks to regulators’ ham-handedness.

I’m not against thorough regulation of the banks, and admit to having an honest disagreement with those who favor more stringent oversight of the industry. But everyone should agree that the best regulation is consistent, even-handed, and as transparent as practicable. These annual stress tests are none of those. At the very least, the Fed could explain the differences in its model, but for some reason does not.

What do you think? Let me know!

8 Responses to “The Fed’s Bogus Stress “Tests””

  1. jsc173

    The financial world fell in love with quants a number of years ago. Bankers were never math geniuses and when math geniuses told them they had unlocked the secrets of the universe, they listened. For a number of years the quants forecasts and models were almost spot on, so they earned lots of credibility. But when the wheels started to fall off, whether it was at S&P, Bear Stearns or Citibank, the quants couldn’t answer a simple question: How did you miss it? They never provided an acceptable answer to that question. There isn’t one for them since their admission would have to be their forecast and models were flawed. So, why now is anyone listening to these folks? Stress testing is an important exercise for any company to perform – don’t get me wrong. But to do it the way the regulators have done it tells me they have learned absolutely nothing in the past six years and confirmed that their continued strident approach of telling banks what to do and deciding who will survive and who won’t is a travesty.

  2. rivvir

    Won’t pretend to know that one side or the other is right/wrong. Can’t possibly without knowing what into the formula from each side, and what numbers got plugged into those formulas. Do you know what what into the figuring? Unless you do, you can’t know, either. When i see wells come up with a hypothetical loss of only, i repeat, only, because only certainly fits going by just recent past experiences, i have to look at that figure with a very skeptical eye. Did you? If not, why not? Regards

    • Monica

      . HOWEVER, Woman B claimed she had never said ayhtning to A about my wife spreading the rumors and that she was simply concerned about her. She was sorry, apologized, but understood if my wife didn’t trust her as a friend. My wife was hurt, but choose to forgive woman B and move on and attempt to repair things with woman A.The next morning, woman B went to A and told her what my wife had done to her. Woman A was concerned about the accuracy of the information she was getting from B. Woman A asked her again if she was sure that what she had said at the party was true, including the party about my wife telling many different people and maliciously attempting to start the rumors. B said this was all true again, and that my wife was really upset with A and wanted to bring her down with what she said.A week later, my wife tried to talk to woman A to apologize for what was said. Woman A would not even look at my wife. She said she was done with her as a friend. She explained that woman B had come back to her to tell her she had been talking about her AGAIN, and she reiterated about the fact she had been spreading the rumors maliciously and my wife wanted to hurt woman A. None of this was true. Woman A called my wife a slew of fowl language in front of me, in front of dozens of her close friends and in front of many of my wife’s friends. She stated that she was lying because woman B had said these things to her twice, and that she wouldn’t lie.My wife is woman A’s boss. Woman A is letting this effect her work. Woman A has cut off all communication with my wife outside of work. Woman B is now completely avoiding my wife entirely as well as woman B’s husband, who is a close friend of mine.My wife forgave them both for what happened. Several weeks has passed. I have a hard time forgiving these people and wanted them to ever be back at our home. They were both very good friends of my wife’s and now she feels alone and isolated because her two best friends destroyed their friendship. I even lost a close friend. The collateral damage goes very deep, since these were mutual friends of almost everyone we know.My wife wants me to move on, but I have such a hard time with that. My wife was trying to do the biblically accurate thing to hold a fellow sister in christ accountable and her other sister in christ; who was not a new christian, but a strong one, threw it in her face. She broke her trust not once, but twice.I just think she doesn’t need to be friends with these people if this is how they treat their relationships. I don’t feel comfortable having them around my home if this is what they choose to do.What do you think?

  3. oy

    I don’t know whose numbers to believe, but you seem entirely too eager to believe the Fed is wrong and the banks are right on that basis of next to nothing.

  4. Patrick

    Excellent work Tom once again. Keep up the writing and thorough analysis. Just because the government says something does not make it true. We need more people, writers, analysts, and journalists to do more than simply parroting what the government and regulators want heard.

  5. Anonymous

    Tom-
    Thanks for being one of the seemingly few remaining non-bank bashers with any kind of platform. I know you do conferences with Source Media. Do you still read American Banker? Does anyone? They are to the left of the Huffington Post now. It’s like Tiger Beat Magazine with Elizabeth Warren and Richard Cordray playing the roles of their heart throbs. It’s becoming unrecognizable as a legitimate news source for the industry.

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