Or, Is It the Naive Government’s Stress Testing Exercise?
More Lack of Planning and Insight from Our Regulators and Government Officials
About one month ago–on April 7, to be precise–we asked, Where Will the Bank Stress Testing Exercise Lead?
In that post, we wrote that the tests could be designed one of three ways: (1) with a positive bias to ensure that all or almost all of the banks could pass the tests, (2) with no bias to get a honest—though not necessarily accurate—assessment of each bank’s financial condition (with accuracy constrained by the implicit and explicit assumptions built into the exercise), or (3) with a negative bias to ensure that most or all banks fail the test.
Given the various news reports that fourteen of the 19 banks may have “failed” the tests and that the fourteen have since been negotiated down to ten that may “require capital,” it doesn’t seem that the tests were designed or biased to generate positive results. In retrospect, it doesn’t seem that the economic assumptions were particularly negative–see We Can’t Subsidize the Banks Forever in today’s edition of The Wall Street Journal for evidence that first quarter economic activity and statistics were worse than projected in the exercise. Note, however, that if they were designed with a positive or optimistic bias, then the regulators who designed the Supervisory Capital Assessment Program (SCAP) wre/are horrendously clueless and incompetent, and that’s not outside the realm of possibility.
As we wrote last month, we can’t imagine anyone designing a negative bias into the tests; so, that means that, most likely, the government sought an “honest” though not necessarily accurate assessment of each bank’s ability to absorb additional losses.
That was and is problematic given the amount of publicity generated about the program. It would have been much better to perform the tests in total secrecy–in what appeared to be a disjointed, disorganized, ad hoc, and unsystematic manner to belie any sense that a thorough investigation or comprehensive and national approach was being undertaken. (They should have been standardized but secret tests with no publicity or acknowledgements of their existence.)
The three-day delay in announcing their findings shows that the regulators–the Fed, the OCC, etc–were unprepared for the results. As we wrote back then, there was no scenario analyses of the stress test outcomes. For examples, what will we do if fourteen banks require more capital, all nineteen, what about two giant ones, etc?
It’s another example of government officials being too rash and not thoughtful enough for their own–and the economy’s–sake. That’s why the road to hell is paved with good intentions.
When we find the time, we’ll expand this post later today or tomorrow, but the events of this week show that the government’s response to the Liquidity Crisis, which is, in fact, a crisis in confidence in financial intermediaries, is no more thoughtful than its reaction to the Mortgage Debacle, and that panicked and over-publicized response created the Liquidity Crisis in the first place.
Please, folks, first “do no harm,” which means that you have to think before acting or calculating. Now where have you seen that before?
