Thursday, April 16, 2009

Bad timing for stress tests

Treasury Secretary Geithner's "brilliant" stress test plan unfortunately cannot be coming at a worse time for some banks. The economy is stabilizing and conditions are starting to improve after a brutal, 2-year erosion.

Many savvy bank analysts understand that the banking sector is pro-cyclical, meaning that asset performance, lending and earnings go up when the economy improves and they go down when the economy deteriorates. Some insightful people also realize that with the yield curve now extremely steep, banks will be able to "earn" their way out of most of their difficulties. This was mentioned recently by Warren Mosler and Muhammed El-Arian of Pimco.

However, with the stress tests taking place now there is a strong likelihood that some banks won't make the cut. Indeed, it almost seems to me that some banks MUST fail just to show that Geithner's plan was not some kind of sham. While I am not a conspiracy theorist by nature, I can't help thinking this way--that someone will have to be "sacrificed" so that the test looks legit and tough.

Who will it be?

That's the big question, but you can rest assured that some banks--and perhaps even a very big one--will have to "fail."

If it's a big bank or, if many banks are deemed to be deficient, it could destabilize markets once more. And for what? No decent reason at all, because given the current change in conditions all banks will be in fine shape in a year.

Of those who will be sacrificed some might not make it back. Nor will their shareholders who are innocent of any wrongdoing. It's just another execution all in the name of "paying back the taxpayer."

Stress tests should have been performed in 2007. Doing them now at the bottom of an economic cycle and amid a populist revolt is sheer folly. But now that I think of it, stress tests were performed in '07, by the brilliant folks at Standard & Poor's and Moody's. What a world!

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