What’s next for the banks?

To reveal or not to reveal, that is the question.  At least that is what’s being asked and discussed by some about the ongoing stress test conducted by the Treasury and FDIC.  A lot of the debate are revolving around the pros and cons of revealing the results of the test.  True enough, each side raises seemingly good points.  Although the public already has an idea of who will pass the test (guess who?), it might simply boil down to specifics if revealed and other public-stress-mitigating information if not revealed.  Let’s first observe the two sides.

Those arguing for the revelation of the results to the public seek what has been missing in bank transactions and government interventions – transparency.  The results might even be legally required to be disclosed, since shareholders hold the right to find out.  And alas, the public is already a big shareholder of the banks. undergoing the test.  Without disclosure, the investing public could run amok speculating, which ones are indeed in good shape and which ones are struggling. Knowledge is power, so knowing are doing well and who are not would inform and warn the public of who among the banks they should embrace  and who they should stay away from.

However, the other group who are against disclosure are concerned about the implications of the results being made public.  While it has already been said that none of the 19 banks will fail, the specifics of the result, if they were to be revealed are still unknown.  Generalities might not be harmful, but once oversharing happens that allow people to dig deep into what the report actually contains, i.e., how the banks are in fact doing, who are healthy and who are not, could prove damaging to the system.  The rally we are seeing at the moment might just end sooner than they are expected to.  As the earnings season continues, banks are individually surprising investors of their newly found profitability.  Dubious as some of the numbers might be, some are already beginning to think they are out of the woods.  Yet the results that have so far come out are from the top players, Goldman Sachs and JP Morgan.  The more problematic banks are still cooking up their books.  Revealing the result of the stress test that’s conducted could show these banks are not as good as their numbers make them seem to be.

But reveal or no reveal, does it really matter? Yes or no, the main point is something else.  Either way, the results might just be unnecessary. Or useless.  Yesterday, Nouriel Roubini called the stress tests “fudge tests”.  Although his (and many others’) main point was simply that the “baseline scenario” that the testing institutions have used/are using are no longer relevant because the current  state of things have already allowed the current numbers to surpass the scenarios the FDIC/Treasury are using, he was nice enough to elaborate and prove:

1. Take unemployment: In March of this year the actual unemployment rate was already–at 8.5%–much higher than the baseline scenario for the first quarter (7.7%) and higher even than the adverse scenario’s 7.8%. Even the average unemployment rate in the first quarter–8.1%–is well above both the baseline and adverse scenarios.

2. [B]ased on the FDIC graphs, the GDP growth rate would be -1.9% in the baseline scenario and -2.1% in the adverse scenario. If we plug the current consensus estimate of Q1 GDP growth and then compute the year-on-year four-quarter percentage change, we get a figure of -2.3%. Thus, based on consensus estimates of GDP for Q1 2009*, the four-quarter contraction of GDP will be–in the first quarter of this year–already worse than both the baseline scenario figure (-1.9%) and the more adverse scenario figure (-2.1%). And if, as is possible, the GDP contraction in the first quarter is -6% (SAAR), the Q1 2009 vs. Q1 2008 percentage change in GDP will be -2.5%, an even worse figure.

3. The FDIC baseline assumes that home prices will fall–December 2009 vs. December 2008–by 14%, while its more adverse scenario sees home prices falling by 22% during 2009. The fall in home prices in January 2009 relative to December 2008 …compounds to an annual rate of 25.3%, well above the 14% of the baseline scenario and also above the adverse scenario of 22%.

All that only means that the results of the stress test would be useless.  For that matter, there’s not much point about arguing whether to reveal the results or not.  Either way, the numbers would have been useful a couple of months back, not forward.  From the looks of it, the stress test would simply pass to be another failed effort by the government.  Sure it succeeded completing the tests, but it’s quite the opposite in terms of having and effect on the market (Well, alright. We can wait and see.) The PPIP doesn’t seem to be moving too fast, the TALF doesn’t look to be generating too much interest, and this stress test doesn’t look too promising.  So yet again: what’s next for the banks?

*Q1 2009 consensus estimate = -5%

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