Stress Test Debate

See’s Room For Debate.  I like what Yves Smith says.  Post your reactions there or here.

By Simon Johnson

Update (by James): My last pre-results thoughts are at Foreign Policy.

35 thoughts on “Stress Test Debate

  1. What will happen, I wonder, if these banks turn out to have multiples of these capital requirements in the next 6-12 months?

    Or would that fact be hidden behind mark-to-market accounting and regulatory forbearance?

  2. Ely makes the point that always cracks me up: if it really was meant to be a serious stress test where failure was an option, they wouldn’t have been so public about it.

    But then, keeping a lower profile would’ve contradicted the real propaganda goal.

    I think ironically the spotlit nature of it, that it was so obviously a PR exercise meant to artificially induce “confidence”, probably quashed whatever chances it had to instill real confidence, if somehow they really had discovered good news.

    Then again, the record of administration solicitude for these zombies is so well-established that I doubt anything could have put lipstick on this pig.

    (And what was up with administration personnel, and I think even Obama and Geithner themselves, openly saying this was only a stupid trust game? That’s real good message discipline there.)

  3. The first commentator gave the Obama-Geithner a grade of A+ for orchestrating stress test spin. But if the big banks are so darn healthly, why are they so very, very far away from being able to raise capital in the private markets?
    In his op-ed in the NYT’s this morning, Geithner continues to want things both ways. His response has been brilliant–he more or less proclaims–but dark clouds and choppy waters loom on the horizon. Which is it? By the way, no one has ever successfully spun away a monsoon, a hurrican or an earthquake.

  4. One of the things I find truly distrubing and bewildering is that we used the banks numbers, used their risk models and when they didn’t like the answers that their own inputs and models gave them they then got to negotiate. Why have wasted any of the time at all?!?!

  5. nemo, russ, kirk, adam,

    I can’t argue. But my question is:

    what are you doing about it?

    Can we collectively ask experts like Simon Johnson to collaborate with other experts critical of the TARP/PIPP/Stress Tests to come up with a nonpartisan “Plan B” that we the grubby public can support?

    I’m concerned that way too much energy is being spent articulating brilliant criticism without actually sticking one’s neck out in a unified fashion to get something done. That’s a criticism of both Johnson/Bill Black/Brooksley Born and of ourselves who post on boards like these.

    If it’s such a crisis, if it’s so bad, we need to be actively fighting for an alternative. That requires more than criticism from Johnson and other experts – it requires leadership. And from us it requires more than typing, it requires active muscle to put behind their leadership.

  6. Spin? From Geithner? The results are “reassuring” — is this like Ferris Bueller watching the Cubs?

    batter, batter, batter, batter, schwiiiinnnng batter!

    Go Tim! ;-)

  7. I agree; criticism isn’t enough. Has Brooksley Born said anything about the stress tests? If so could you provide a link? I thought she had retired altogether.

  8. Hey, I went to the New Way Forward protests. I am not sure I really fit in because I am not a gray-haired hippie and I did not bring any pots and pans to bang together while chanting.

    Frankly, there is not a whole lot concerned citizens can do because there are too few of us. Prof. Johnson has indicated that he has spoken to people in the administration (current and previous) about alternate approaches, and they are not interested.

    All that is left for me is to rant a bit to make myself feel better. Sometimes it even works.

  9. I am going to disagree with the notion that the Stress Tests were an attempt to really convince people that banks were solvent (e.g. to inspire confidence through propaganda).

    I think Team Obama is a little sharper than that… They neither expected not needed to convince anyone. The purpose of the stress tests was merely to seize the initiative in the media cycle.

    It is absolutely critical for the White House to appear pro-active, not re-active. Even if everyone disagrees the administration, the White House needs to give the impression that it is calling the shots – that they are steering the ship.

    To put it differently:

    For 6 weeks, the stress tests have dominated the financial news cycle. That’s 6 weeks during which the white house controlled the media environment. At the end of this, all they needed to offer was a plausible set of “results”, which they ensured by leak-testing various options. The White House neither needs, not expects, people to really believe the results. Just find them plausible.

    The AIG debacle was an example of what can happen when the president does _not_ control the news cycle, and how hard it is to recover.

    It’s always better to create the news than react to the news.

  10. Dear Nemo,

    I am quite likely less the grey-haired hippie than you are. But is it possible that your type of sarcasm prevents the non-grey-haired hippies from participation?

    I give the older generation some credit for standing up for all those years when I stood down, so I find your contempt for them (“gray hair”, “pots and pans”) not terribly chivalrous, sorry.

    Further, it is obviously not enough for Simon Johnson to merely interrupt his media juggernaut to speak to people in the current and previous administrations.

    It is time for him to WORK WITH the OTHER dissenting economists, policy makers and lawyers to form an ACTUAL alternate plan.

    This requires subordinating the egos of men like Johnson and Bill Black (I don’t think you can subordinate the ego of Paul Krugman, so let’s leave him out of it) to move beyond criticism and attraction to the fawning (overly so, I might say) adoration from the blogs, and move into a leadership position, creating a COORDINATED and UNIFIED alternative for ordinary people to support.

    And, by the way, there are not “too few of us.” I have combed both right and left movements, and there is enormous potential for nonpartisan and bipartisan support for reform. But we need leadership, and that needs to come from the presumed experts, e.g. Johnson, Black, Born, et cetera.

  11. i think this is a fair assessment.

    notice how they kept timmy g away from the media through it all. not that media savvy is a qualification for treasury secretary.

  12. Who cares…. the question is: Are their “bargains” to be had in banking. Billionaire Wilbur Ross thinks so. Breaking out, above their 200 day moving average, buy the dips… it’s a feeding frenzy out there. The water s freshly chummed. The sharks are thrashing, they are devouring everything in sight. What’s not to love? Tune in at 6:00pm to see everyone’s favorite punching bag, Jim “Booyah” Cramer take his umpteenth Victory Lap. …. in your FACE Johnson, doubly for Krugman. What we care about is the RALLY. Economists can take their dismal science, put it in a bathtub, and drown!!!

    Yeah baby.

  13. Dear Bill,

    Sadly, I haven’t heard a peep from Brooksley Born. But when I do, I will post it here.

    I think Simon Johnson (economist), Brooksley Born (lawyer) and maybe a policy guy like Bob Reich (not sure about that last one – maybe you guys could come up with someone better) would make a great triple threat.

    I wish someone (Mr. Kwak, are you there?) would use their estimable reputation to urge them to work together. Or some other similar triumvirate.

    I really worry that a failure to coordinate now will allow a much worse scenario to occur.

    I have been to the ANWF protests, AND the (sigh) Tax Day tea party protests, et cetera. I have honestly tried to gauge the level of support for banking reform on both sides, and it is THERE, but that support requires leadership, not just criticism.

    I’d also like to suggest that a failure of people like Johnson to graduate into a leadership position leaves, for example, the Tea Partiers to the wolf-like jaws of Rush Limbaugh.

    Please be aware that many of the tea partiers I spoke with were actually quite open to smarter ideas and better explanations – they simply hadn’t been provided with any, because we hadn’t bothered to engage them. We had dismissed them, and I would suggest our dismissal of them was in part based on class divisions. That hurts not just them, but us.

    I know it’s a lot to ask, but this is indeed a crisis…

    And Mr. Johnson, Mr. Kwak, please step up to the next level. We desperately need you to function at that higher level. The green room is for narcissists…

  14. Interesting that the WSJ criticizes the SEC
    not for ten years of snoozing at the switch but for failing to control short sales. Clearly the current critical priority is to prevent any counterproductive rational response to all the bank propaganda.

  15. A silver lining….

    President Obama on Thursday unveiled nearly $17 billion in additional budget cuts for the coming fiscal year to underscore what he called an “ongoing” effort to find savings at a time when the government’s costs for bailouts, health care and wars are mounting.

    At this rate, ____________________ (*fill in blank).

  16. I’m not clear exactly what leadership means here? It’s not as if economists can muster an army and storm Washington. It is obvious that Wall Street has complete control of the White House and Congress, so until the next election what is there really to do beside talk?
    Krugman, for example, has a national (global?) audience in his NYT column and every network news producer (except Fox) on speed dial, but he still has no power to influence policy. He spent months arguing for increased stimulus spending (as did others) and outline specific areas it should be spent. It had no effect.
    I’m really not being snarky, but could you point out specific examples of action that might actually have an effect? Complaining about inaction and lack of leadership is just a different flavor of talk.

  17. “One humiliation was heaped on top of another. Regulators ordered Citi to lower second-quarter 1992 earnings by $28 million, saying it exaggerated the value of its mortgage-servicing business. Chastising Citi for its sloppy lending practices, the regulators asserted that nearly 13 percent of its residential mortgage loans were delinquent. As Citi had done sixteen years before in the problem bank episode, it contested the regulators’ findings( NB DON ), saying they were filled with errors. The number was only 5 percent, Citi insisted. Whatever it was, Braddock, though well-regarded as a manager, was ultimately responsible, and took the fall, adding to Reed’s reputation as Citicorp’s resident “”serial killer.” In Reed’s view, the mortgage debacle was the “”most dangerous” point for Citi. “”It was a question of their [the regulators’] feeling that we had serious control problems.”

    In other words, Citi, in 1992, contested such results. In fact, if you read this chapter of Zweig’s book on Wriston and Citi, you’ll hardly be surprised by what’s happening.

    I posted this on Justin Fox’s blog, but I’d like to do it here as well, just to give another point of view:

    To be noted:

    February 25, 2009

    U.S. Treasury Releases Terms of Capital Assistance Program

    To view the White Paper, Term Sheet and FAQ, visit

    Alongside the forward-looking economic assessments now being conducted by the Federal banking agencies, the U.S. Department of the Treasury today announced the terms and conditions for the Capital Assistance Program (CAP). The CAP is a core element of the Administration’s Financial Stability Plan.

    The purpose of the CAP is to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers.

    Under CAP, federal banking supervisors will conduct forward-looking assessments to evaluate the capital needs of the major U.S. banking institutions under a more challenging economic environment. Should that assessment indicate that an additional capital buffer is warranted, banks will have an opportunity to turn first to private sources of capital. In light of the current challenging market environment, the Treasury is making government capital available immediately through the CAP to eligible banking institutions to provide this buffer. Details of the forward looking capital assessments can be found at

    Eligible U.S. banking institutions with assets in excess of $100 billion on a consolidated basis are required to participate in the coordinated supervisory assessments, and may access the CAP immediately as a means to establish any necessary additional buffer. Eligible U.S. banking institutions with consolidated assets below $100 billion may also obtain capital from the CAP.
    To clarify the broader context and objectives for the Capital Assistance Program, and its role in the Financial Stability Plan, the U.S. Treasury also released a white paper on the program, as well as a set of frequently asked questions. Both can be found at ”

    Now, how on earth could revealing that certain banks were insolvent by administering a stress test lead to restoring confidence? It can’t. The only way to make sense of CAP is to assume that the govt is going to find out which bank needs what, and then go about helping them get it. The govt guarantee is the only way to restore confidence. In other words, don’t worry, because, whatever the needs,the govt will provide them.

    Somehow, the stress tests came to be seen as a search for solvency in and of itself. Don’t ask me how, since it doesn’t make sense, if you’re dealing in confidence. As for bank stocks, one could assume that the price of some bank stocks would go up once they were guaranteed by the govt. On the other hand, that positive is counterbalanced by the possibility going forward of stock dilution in the banks likely to need help and have the stock price rise on govt help. All in all, this has been a strange process. I have to assume that the govt is guaranteeing the solvency of these banks, since that’s what I hear them saying.

  18. Good point.
    But it is just as important WHAT news you create when you’ve created the opportunity to to create the news.
    You’ve hit on the mechanism, but the message is still irrationally optimistic propaganda.

  19. Question: Was Yves Smith correct in stating that the stress tests “were administered by the industry based on scenarios provided by the industry”?

    In other words, is that a fact rather than an opinion?

    Guess I’ve been out of the loop too much to have noticed that.

  20. can I give an example? Yes, and I have. Let me repeat: They need to reach out to similarly minded economists and legal scholars and develop a unified & workable “plan b”. At this point, all else verges on narcissism.
    please. I humbly beg you to stop licking simon’s shiny boots/imf pedigree and ask him to take the next step.

  21. Very astute. I want to call especial attention to this:

    our dismissal of them was in part based on class divisions

    This goes for the Democrats, too. I might even say, given that the Finance Wing of the Democratic Party is running the government now, especially for Democrats.

    You can’t put the taxpayers on the hook for two trillion dollars, with no transparency and no accountability, and not so much as a Congressional hearing, and still maintain that we have even the facade of Constitutional government. This is indeed a crisis.

  22. There may be another way, that doesn’t require Simon to get dressed up in a Superman outfit.

    It’s pretty clear that Washington’s prime concern is being in control of the media cycle, and avoiding tough decisions (even the Stiglitz, Krugman dinner with Obama was probably in this category).

    The mid-term elections are too far into the future. Consumer activism is looking like the best option now. If enough ordinary Americans refuse to do business with the banksta institutions popular pressure could undo Obama’s calculus. Professors Kotlikoff and Learner are already pointing the way

    But bear in mind, it could be a very long process. It took decades in the 1800s for the British to get rid of child labour.

  23. Tomaso Spingardi in a recent interview at the London Financial Economics Roundtable presented the key conclusions of a work done for the Economics Centre of Financial Studies on the topic of financial risk controls in financial institutions.

    This is an abstract from the research conducted by Tomaso Spingardi. Banks have the possibility, through a variety of means and instruments, to eliminate, or at least substantially reduced through the technique of risk transfer., a number of risks. Markets exist for many of the risks borne by the banking firm. Interest rate risk can be transferred by interest rate products such as swaps or other derivatives. Borrowing terms can be managed in order to effect a change in their duration and convexity. The financial institution can also buy or sell financial claims to diversify or concentrate the risks associated with its business practice and customer portfolio.

    Tomaso Spingardi maintained that the recent crisis has shown that for many financial institutions the spreading of risk, one of the purported benefits of the originate-to-distribute model, proved to be much less extensive than many believed. When investors were no longer willing or able to finance new structured credit products, many of the largest financial institutions had to fund instruments they could not readily sell or had to meet contingent funding obligations for which they had not adequately planned.
    Banks placed too much emphasis on the mechanical application of value-at-risk or similar model-based indicators. Sophisticated quantitative tools and models play an important role in good risk management, and they will continue to do so. But no model, regardless of sophistication, can capture all of the risks that an institution might face.
    Tomaso Spingardi concluded that those institutions that managed to have better risk management results far better during the recent crisis placed relatively more emphasis on validation, independent review, and other controls for models and similar quantitative techniques. They also continually refined their models and applied a healthy dose of skepticism to model output.

  24. Very enlightening, at least for those who have not been following the Summers/Geithner charade. And, yes, what Yves said was the most cogent and appropriately cynical. I do believe that the Treasury just spent several hundred thousand dollars and wasted a lot of time. Perhaps an ad campaign could have accomplished the same level of “acceptable” disinformation more frugally.

    The stress tests are just the latest of the oligarchs/Treasury/Congress long running and very popular farce, being just an extension of the famous play Other Peoples Money. Interesting, that the public funds the oligarchs contributions and Congress assures that these continue. Wow, what a wonderful symbiotic relationship. Unfortunately, those of us who pay taxes and grind ourselves to the bone earning a living, have paid the screenwriters salaries and the actors, and all to our detriment.

    No doubt, long before the six-month window for capital raising is upon us, many of those who have conspired in this fraud will find ways to ask for more help, because, alas, the stress tests failed to depict the depth of the problem. I am sure that it would be easy to determined, with the collapse of both residential and commercial real estate markets, the unemployment rate adding to the credit card and auto loan defaults, and the rising spate of foreclosures, the inscrutably traunched toxic assets are collapsing in value as we speak, such that no degree of MtM adjustments will enable them to survive. And, I still predict that the PPIP will turn out to be the ultimate red herring in the mix.

    Once again, to any truly cogent spectator, the Stress Tests are intended only as an opaque ad campaign, nothing more, nothing less, and as such should never have been visited on the innocents.

  25. This is a wonderful response. By all means, enjoy the rally, but remember, about August/September, get rid of whatever you decide is worth buying now. It won’t be worth a damn by the end of the year.

  26. I agree. Look at what I said at further down. It is “pure PR” and nothing serious (as Yves ably pointed out). And, with the Chief Economic Advisor and Treasury Secretary providing the appropriate imprematur, it will carry the day. Unfortunately, they will have to find an encore to play out in another three to four months. Perhaps a new version of the Stress Test Smoke and Mirrors. The ADD Public will have forgotten by then, and some new device will be thought of. This was only ACT I, and Summers and Geithner did attend the Prayer Breakfast this morning with the President, just to get a little piece of mind. Prayer may be all they have at this point, without putting some Big Players out of business.

  27. The humor is so “right on” it’s scary. Tiny Tim is in deep S___, and we all know it (if we study a little).

  28. The scary part is, what happens when the banks fail without any regulatory intervention planned? Has anybody considered that. Since each seems to own the others derivatives (incest, I believe), then when one goes (GMAC most likely first) then that weakens the others in dramatic ways, and like dominoes….

  29. Lun,

    I agree that consumer activism is a necessary leg of reform. I would classify it as part of the range of necessary action that we ordinary people take.

    But I also note that none of the economists who attended Bretton Woods had to wear a Superman outfit.

    I fear that we’re creating a false scenario, wherein anyone who dissents is somehow automatically heroic.

    This outlook precludes the recognition that heroics are beside the point, and that it is not necessarily an extraordinary act for men like Johnson and Kwak follow through on their ideas with SUBSTANTIVE action.

    And in saying this, I would like to emphasize that these (Johnson and Kwak) are the first two “thought leaders” (sorry, that’s a horrible term) I would trust to do that, which is why I’m being such a pain in the arse here. After that, Bill Black and Brooksley Born. And after that, Joe Stiglitz.

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