More Stress Test

The Fed released the stress test results earlier today.

The projected $600 billion in losses over the next two years under the "more adverse" scenario are in addition to the estimated $400 billion in losses and write downs are already taken by these 19 banks. Because of existing resources, future earnings, and planned transactions, the Fed estimates the banks need to raise $75 billion in capital. This is a huge question mark: Is this enough?

Note: Shuffling preferred to common doesn't really help with solvency (except with some ratios). See Paul Kasriel's Preferred Equity into Common Equity – Accounting Alchemy?

Some of the numbers don't make much sense. Using BofA as an example, the indicative two year loss rates for first lien mortgages are 7% to 8.5%, and I believe BofA is in worse shape (because of their acquisition of Countrywide) than most banks. So I would expect losses substantially higher than the indicative rates. Instead they were lower (only 6.8% of first lien mortgages).

And I was expecting more details. Under Commercial Real Estate (CRE), the Fed grouped Construction & Development (C&D), Multi-family, and other non-residential in the same category. However the indicative loss rates suggest these assets perform very differently (C&D the worst), and it would help to break out each category. Especially since it appears the banks have under reserved for CRE losses.

How can BofA only have 9.1% in CRE losses over two years under the "more adverse" scenario? I'd like to see their exposure to C&D, and other categories.

Also, I was expecting to see the losses and loss rates for both the baseline and more adverse scenarios. Although the "more adverse" is the new baseline, I was hoping to construct a new scenario based on differences in these losses. Without the baseline data, this is impossible.

On the Obama dinner with several economists, Michael Hirsh writes: No-Stress Tests

It’s not that Barack Obama isn’t aware of what’s at stake. That’s very likely why on April 27, the president gathered in some of his chief outside economic critics —including two of the most vociferous, Nobelists Joseph Stiglitz and Paul Krugman—for a secretive dinner in the old family dining room of the White House. Also in attendance: Paul Volcker, who has one foot in and one foot out of the administration as the head of Obama’s largely cosmetic economic recovery board; Princeton economist and former Fed vice chairman Alan Blinder; Columbia’s Jeff Sachs; and Harvard’s Ken Rogoff. Representing the home team, as it were: Obama’s chief economic adviser Larry Summers, Treasury Secretary Tim Geithner and Chief of Staff Rahm Emanuel. Why did Obama hold the meeting? “I think he wanted to hear the [opposing] arguments right in front of him,” says Blinder. “All I can say is if the president of the United States devotes that much personal time, and it was about two-hour dinner, he must want to hear what people outside the administration are saying and hear what his own people say in rebuttal to that. Why would you do that if you aren’t at least turning over your mind what to do next?”

What to do next? If this fails, nationalize.