Most people, of course, pay little attention to the wily moves of the Federal Reserve Board. We like to keep our eye on them, though, just to be safe since we are living in an era some are now calling a “bankocracy.”
That’s how I found myself the other day wrestling with a press release put out by the best and brightest of our economic minds at the Fed. It said they’ve completed the latest round of CCAR tests of the nation’s banks. CCAR stands for Comprehensive Capital Analysis and Review. It’s a sort of “stress test” for banks. In this case, 19 of the country’s biggest (not necessarily strongest) banks were thrown under the CCAR, as it were.
To the extent it’s possible, the Fed was actually crowing about the results. Here’s what that looks like in “Bureaucratese,” the official language of government agencies:
“…The majority of the largest U.S. banks would continue to meet supervisory expectations for capital adequacy despite large projected losses in an extremely adverse hypothetical economic scenario.”1
Translation into terms we can comprehend: “If another Great Recession hits, most of our banks won’t fail! Don’t worry, be happy!”
Now to be fair, it’s closer to an 80% survival rate. According to the results of the test, only 4 of the 19 major banks got a failing grade.
I’m sorry for going “glass half empty” here, but 20% of our banks imploding is not a good thing. Right now, the Federal Deposit Insurance Corporation is on the hook for nearly $5.5 trillion in deposits. It has only a tiny fraction of that in reserve, so more failures of any significance will further stress the system.
The problem is that in an election year, the Fed has to show that the bank bailout plan worked and our financial system would remain solvent even if another shockwave hits our economy.
The markets, of course, took the announcement as the glass (more than) half full. Investors responded with near euphoria, and all sectors rose sharply on the “positive” news.
But it’s worthwhile to look at the Fed’s report to see what they consider a financial crisis, particularly if the institution holding your deposits is among the flunking four: SunTrust, Ally Financial, MetLife and Citi. You can read the full report here:
In a nutshell, here’s what the “extremely adverse hypothetical economic scenario” looks like:
- Peak unemployment at 13%
- A 50% drop in equity (stock) prices
- A 20% drop in house prices
- Total duration of 9 quarters or 2 years, 3 months.
If that happens, the Fed estimates the nation’s 19 largest banks alone would take it on the chops for $534 billion. That doesn’t begin to estimate losses for the entire banking system.
Another dubiously positive figure from the Fed’s test shows real estate related losses amounting to less than a third of the total hit taken by the big banks. Tangent Capital Partners’ Christopher Whalen is skeptical: “Since real estate is half the total $13 trillion balance sheet of the US banking system and more like 3/4 of total exposure if you include RMBS [real estate mortgage backed securities], how does the Fed manage to keep total real estate losses below $150 billion in the stressed scenario?”2
Considering the impact of the subprime housing bubble’s burst in 2008 that brought on the Great Recession, the Fed’s latest CCAR estimate seems weak (IMHO). According to The New York Times, roughly 4 million people in America lost their homes to foreclosure between 2007 and early 2012. With the overall median value of a home in the U.S. estimated to be $128,000 by the National Association of Realtors, the real fallout of residential real estate loss could reach closer to $300 billion should we experience another economic shockwave.
Add to that another 20% drop in homeowner equity and the underwater mortgage to default to foreclosure spiral would be in full force again.
Seemingly unburdened by wisdom from past experience, sophisticated investors in the “smart money” crowd aren’t nearly as troubled as I am over the Fed’s rose-colored report. The Dow Jones Industrial Average has gained back the ground it lost to the Great Recession.
In my view, the economic picture in America can be compared to a tightrope walker crossing a great chasm. In 2008, turbulent conditions caused our economy to wobble from side to side and nearly fall to its death. Shaken, but not mortally injured, its forward progress stalled and all observers realized that calamity was only one misstep away. Many watching were seized by fear and doubted the economy’s ability to recover.
Now the headwinds have lessened and the experts are saying the economy is back on its feet and will press on to victory across the perilous chasm even if those storms return with substantially more force.
What they are not telling us is that the “rope” our economy stands on is fraying at both ends, temporarily kept from snapping by more strands of sovereign debt. They would have us keep our eyes on the tenacious performer and not the thinly stretched twine temporarily holding the rope in place.
My advice, remain cautious. The forecast calls for more headwinds ahead.
I would love to hear your thoughts, post them in the comments below.
1Board of Governors of the Federal Reserve System Press Release, March 13, 2012 accessed 3/14/12 at http://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htm.
2Christopher Whalen, “Bank Stress Tests and Other Acts of Faith,” ZeroHedge.com, accessed 3/14/12 at http://www.zerohedge.com/contributed/2012-11-13/bank-stress-tests-and-other-acts-faith.