SHOULD WE BELIEVE IN THE RESULTS OF THE STRESS TESTS ?

The so called “Stress Tests” were supposed to check the stability of major Financial Institutions (F.I) in the face of a deepening domestic crisis. This was an exercise where dark scenarios borrowed from economists and their future projections data, were used to estimate the potential losses these financial institution might incur. Based on those results, the regulators were going to either require more capital from the FI, provide further access to the Tarp or extend their access to different  short term funding windows.

After all the hype about what to expect, the results just proved to be as illogical as the publication of the report on starting such a process. If the intent was to test the viability of F.I in the face of pressure from shareholders and short sellers, it means that the process couldn’t possibly be legitimate since the last thing the regulators wanted was to contribute to another Bear Stearns.

Did the street actually hoped that the Regulators would come out and commit systemic suicide by exposing the risk and potential losses  Financial Institutions, might encounter? Doing so would have defeated the entire purpose of all the programs launched to mitigate their exposure to systemic risk.

In the end, the published results will be full of double-entendre and provide alternatives in the place of worries and warnings. And the reasons why it wouldn’t be otherwise are obvious: We don’t need more STRESS !

Looking back at the reckoning of the Financial stress on all economies in 08, we’ll have to remember that the causes are not all linked to the subprime mortgage industry failures.

Marc Handler of the NYT puts it to light: ” By itself, money from China is not a bad thing. In the 19th century, the United States built its railroads with capital borrowed from the British.

But Americans did not use the lower cost money afforded by the Chinese investment to build a 21st century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes. Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations”

I think it’s clearly how we got here; although it went even further as those securities found hungry buyers all over the world, that risk then traveled along and spread like a virus.

IS THE U.S FINANCIAL SYSTEM GOING TO GET BETTER or CRASH SOON ?

From all indications, the situation in the banking system is not as calm as Bernanke looks on tv! For the past couple of years, overall banking lending was way too high. Banks were lending at low rates to anyone that asked for it. All the ratios went out of the windows in the race to securitization. Almost anything with an average of 6 months of payment history had to be pooled and sold off in a security. Now what?

Here is the problem, it now appears that local banks can no longer find where the steady flow of payments is going to come from. What that means is that there is nothing left to pool, no new security to sell and move off the balance sheet. They are stuck with all these “assets” they can’t get any money from. That’s one of the reason why banks are forced to borrow on the “low-low” from the Fed. They’ve already burnt all their reserves, and don’t want the public to know ! It could be chaotic out there if people were to find out that banks lent all the money they had and are forced to inject new cash because they still have to maintain the liquid reserve requirement.

How bad is it going to get before it’s over? Not soon, because as long as banks are using the Term Auction Facility (TAF) , it means that they are still struggling. And this is America, why wouldn’t the Fed Reserve want to disclose the names of the banks that are borrowing under the TAF? Probably because the street might start ditching those banks stocks or take their money out of there ( that’s for sure).

It’s getting interesting : Let’s look at the NonBorrowed Reserves which is a measure of the banking system reserves, consisting of Total Reserves (member bank deposits in Federal Reserve Banks, plus vault cash), less funds borrowed from the Federal Reserve Discount Window. This net NonBorrowed Reserves is now NEGATIVE by more than 15% ! Click here for the CHART…This hasn’t happen for a long long time.

 AN

Sources: UBS releases , Fed Reserve , Bloomberg , FT, WSJ , Mish blog     Courtesy: Rowd-Master