Roubini Says Stress Tests Not Credible

Written By Brian Hicks

Posted May 5, 2009

 
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According to various reports this morning, Treasury Secretary Tim Geithner fudged it a bit two weeks ago when he declared that most of the 19 stress-tested banks have “adequate capital”.

Because by my own math, Geithner’s “most” would imply that a minimum of 10 of those banks had essentially passed the capital test, proving to some degree that they were solvent.

However, today we have found out that the word “most” has been twisted to mean something less than half. Stress test leaks now suggest 10 of the 19 largest U.S. banks will be instructed by regulators to raise more capital in order to survive the slump.

That will likely reintroduce shares of financial stocks to the laws of gravity again now that the truth behind their plight begins to see the light of day. Beneath the glare, it is not as rosy as they would have you believe it is.

Yet, the banking bulls continue to insist that the emperor is wonderfully dressed.

Of course, long time banking bear Nouriel Roubini still says otherwise….

Here’s his take on the stress test and what they will eventually reveal.

From the Wall Street Journal by Matthew Richardson and Nouriel Roubini entitled: We Can’t Subsidize the Banks Forever

“The results of the government’s stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup and Bank of America may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape.

This would be good news if it were credible. But the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak — $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. With the U.S. banks and broker-dealers accounting for more than half these losses there is a huge disconnect between these estimated losses and the regulators’ conclusions.

The hope was that the stress tests would be the start of a process that would lead to a cleansing of the financial system. But using a market-based scenario in the stress tests would have given worse results than the adverse scenario chosen by the regulators. For example, the first quarter’s unemployment rate of 8.1% is higher than the regulators’ “worst case” scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year — the stress test’s worst possible scenario for 2010.

The stress tests’ conclusions are too optimistic about the banks’ absolute health, although their relative assessment is more precise, because consistent valuation methods were used. Still, with Thursday’s announcement of the results, it shouldn’t be a surprise when the usual suspects emerge. We fear that we are back to bailout purgatory, for lack of a better term.”

By the way, according to Blackrock’s Bob Doll, the financials are ripe for a correction that could help the S&P 500 erase as much as 100 points, or about half of the rally.

About the financials Doll told Bloomberg, “The more they’ve gone up, the more vulnerable they are to a correction. They’ve been non-stop up for the last bunch of weeks as if all problems got solved, but they are not all solved.”

Beginning Thursday, the rubber meets the road.

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