“Maybe it should come as no surprise that President Joe Cool’s administration has a laid-back view of bank stress. Investors expected the government to be a bit more intense in tests of the nation’s biggest banks. After all, if nightmare scenarios were appropriate in urging passage of a $787 billion stimulus package, they should be appropriate now to gauge a bank’s ability to withstand losses.
Sadly, that’s not the case, at least according to the stress-test criteria laid out by the Treasury Department and bank regulators Wednesday.
That is bad news for investors, taxpayers and the economy. The longer we keep trying to avoid the reality of banks’ dire straits, the longer the financial crisis will stretch. The lack of sufficient stress in the tests is especially surprising since a big lesson of the past two years is that the worst can happen, and then some. In times like these, the government and investors need to play “What If?” even when it involves some outlandish possibilities.
The failure to do such worst-case planning, even after plenty of red flags, probably made the after-shocks to the financial system from the collapse of Lehman Brothers Holdings Inc. far worse than they should have been.
Perhaps the biggest lesson, though, is that banks, like plenty of other companies, will get drunk on their own Kool-Aid. And regulators are supposed to be the ones who abstain.
Its not the banks, but Mr. Market that is failing the stress test.
Source: Bank Tests Ignore Black Swans, Rely on Grey Goose David Reilly Bloomberg, Feb. 27 2009 http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_reilly&sid=av_BTw3JLGOs