Fed's Bank Stress Test Doesn't Account For "Black Swan"

February 25, 2009 5:39 PM EST

Today, the Federal Reserve answered some questions on the bank "stress test", which they say is being conducted, "to determine if the largest U.S. banking organizations have sufficient capital buffers to withstand the impact of an economic environment that is more challenging than is currently anticipated."

Banks have been instructed to analyze potential firm‐wide losses, including in its loan and securities portfolios, as well as from any off‐balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two year time horizon (2009, 2010). The capital assessment will cover two economic scenarios: a baseline scenario and a more adverse scenario:

Baseline scenario (average):

• GDP: -2% (2009), +2.1% (2010)



• Unemployment Rate: 8.4% (2009), 8.8% (2010)



• House Prices -14% (2009), -4% (2010)

Adverse scenario:

• GDP: -3.3% (2009), +0.5% (2010)



• Unemployment Rate: 8.9% (2009), 10.3% (2010)



• House prices: -22% (2009), -7% (2010)

The govenment's so-called "adverse scenario" is no "black swan". How about GDP down 8%, Unemployment at 14% and house prices down another 40%. Nothing like that could ever happen - right? What would the stress on the banks be under that "adverse scenario?" Would any survive?

The test doesn't seem to go far enough to "stress" the balance sheets of the nation's largest banks.



Here is a Link to the FAQs of the govenment bank "stress tests."

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