Friday, May 08, 2009

Stress Tests and Green Shoots

Now that the banks have been blessed by Pope Tim Geithner the First, we'll move on to the real world and watch reality play out over the last 18 months. Roger Ehrenberg, a former colleague of mine, penned an excellent post titled "What keeps me up at night," explaining how the government's strategy has been to "buy time" in what it thinks is a crisis of confidence. Ehrenberg doesn't say such, but the government's view is basically that if we can TELL people that things are getting better, then things will get better eventually - and that banks will be able to earn their way out of the problems they are having by earning the capital cushions that they need.

Now, to me, it's clear that this is not a confidence issue. No matter how many times you tell the American people that we have ample "green shoots" in the economic garden just because job losses declined from 680,000 losses to 600,000 LOSSES - it doesn't help the people who are losing their jobs or at fear of losing their jobs afford the things they need. No matter how many times you tell people that home prices are stabilizing, it doesn't make their mortgage payments any lower when their interest only adjustable rate mortgages reset and they have to start paying down principal with a monthly payment that's drastically higher. No matter how many times you tell me there is no inflation, I can see that my health insurance costs are higher, and that it cost me $8.99 for a little container of pignoli nuts last night.

John Thain, the former CEO of Merrill Lynch, said something in the early summer of 2008 that stuck in my head. Without quoting Thain verbatim, he basically said "We will not need more capital as long as things don't get worse." There was only one problem - things got worse.

Which brings us to the much ballyhooed stress tests. Never mind that we're basically already bumping up against the "adverse case" assumptions that the tests used as inputs - we only need to ask ourselves one question : If the guys running the test - Geithner, Bernanke et all, have already demonstrated to us that their economic model does not work (and it's clear to me that this has been demonstrated, as they each completely failed to foresee this entire fiscal maelstrom from their perches of oversight which were supposed to foresee EXACTLY that), then why do we care what their model says?

Back in the summer of 2007 many quant models "blew up," - leading one quant to claim "we saw 10 standard deviation moves for 5 days in a row." Channeling my inner Nassim Taleb, I would respond, "Don't you think it's possible that your MODEL miscalculated the standard deviations?" Maybe (in fact, CERTAINLY) - those were not actually 10 standard deviation moves - the risk was a lot higher than the model predicted.

The ratings agencies have been rightly vilified for giving top AAA ratings to many securitized products which turned out to be worthless or nearly worthless. Their model was incorrect.

An anonymous friend of mine who runs a corporate bond trading desk at a major Wall Street firm, sends me the somewhat rhetorical:

"Question: is the govt administering stress tests on banks finding them not insolvent and causing shares to rally in which they have multi billions at stake much different than ratings agencies assigning AAA ratings to all the shit CDO's that are paying them?"

I don't think the government is concerned about marking up the capital investments it's made in the banks - after all, they've already proven those are just dollars which they are more than willing to create out of thin air - the government is concerned with a different investment - the American economy and financial system. They hope that they can talk the country down from the ledge, and that everything will just be fine eventually. The problem as I see it, and as Roger elaborates, is that they've failed to make any of the tough choices that would actually lead to a cleaner more viable financial system, "The Administration and Congress have clearly taken the path of least resistance," instead opting for the Martingale double down approach of ponzi-perpetuation -"avoid addressing the problem and hope it heals itself."

Eventually, reality will cath up with us. If the government is lucky, it will be the reality where everyone is prosperous and Americans continue to somehow spend money they don't have. I just don't see how that works.

fingers crossed...


1 comment:

Anonymous said...

Nice post, KD. Mr. P points out that the stress-tests also extrapolate forward the juiced Q1 bank PnL. Seems unlikely banks will be able to sustain that sort of bogus run, so the offset PnL provides to the losses calculated in the stress-tests is likely to be considerably lower.

Oh, and who believes the crap loss assumptions to begin with? It's beyond bogus.

One last thing. Fannie may reported dismal numbers this morning and they see house prices continuing their slide this year. So much for the thesis that the carnage in the conforming loan market was over.