At least 15 of the nation’s 19 banks undergoing federal stress tests this week would fail a stricter test based on more objective economic assumptions and stricter evaluation procedures, according to an analysis released today at the National Press Club by Martin D. Weiss, Ph.D., president of Weiss Research, Inc.
"The stress tests results are akin to ratings," declared Weiss, formerly the president of a national rating agency. "But no objective rating agency would stand behind them. The exams are too easy; the banks get to take them home with cheat sheets; and if they don’t like their final grade, they can appeal for a better one. If, despite all this, some large institutions still come up short on capital, it will imply far deeper troubles than the Treasury or the Fed dare admit."
Based on data provided by TheStreet.com Ratings, by the Comptroller of the Currency (OCC), and in first quarter financial statements, Weiss offers the following evaluations for the 19 institutions undergoing federal stress tests:
Weiss Evaluation of 19 Institutions Subject to Federal Stress Tests
Institution Assets ($Bil.) Weiss Evaluation
---------------- ----------------
J.P. Morgan Chase & Co. 2,079 Risk of failure
Citigroup 1,823 Risk of failure
Wells Fargo & Co. 1,286 Risk of failure
Goldman Sachs Group 885 Risk of failure
GMAC LLC 189 Risk of failure
SunTrust Banks Inc. 179 Risk of failure
Fifth Third Bancorp 119 Risk of failure
Bank of America Corp. 2,322 Borderline
Morgan Stanley 659 Borderline
American Express Co. 121 Borderline
Bank of NY Mellon Corp. 203 Adequate capital
---------------- ----------------
Assets of 19 Institutions, Grouped by Weiss Evaluation
Total Assets
Weiss Evaluation ($ Bil.) (%)
------ -----
Risk of failure 6,560 56.5%
Borderline 4,035 34.7%
Adequate capital 1,025 8.8%
------ -----
Total 11,620 100.0%
Of the $11.6 trillion in assets held by the 19 institutions, those considered at risk of failure represent $6.56 trillion, or 56.5 percent, of the assets; while those considered borderline hold $4 trillion, or 34.7 percent. Only $1 trillion, or 8.8 percent, of the assets are held by institutions with adequate capital, according to Weiss’ analysis.
Although the precise metrics of the federal stress tests have not yet been released, a review of the Federal Reserve’s white paper, "The Supervisory Capital Assessment Program Design and Implementation," indicates three major differences between the federal stress tests and Weiss’ analysis, as follows:
1. The Assumptions: The federal stress tests consider strictly a one-year further decline in GDP, in contrast to prior government stress tests that assumed a 10-year decline.(1) Further, the 2009 baseline assumptions for GDP is a 2 percent decline, or only one-third the pace of the current GDP decline. Most important, instead of a typical worst-case scenario used in most stress tests, the current program uses a milder, "alternative more adverse" set of assumptions. These are only moderately more severe than the baseline scenario, still assuming a 2009 GDP decline of only one-half the current pace of contraction. The Weiss analysis does not include macro-economic projections, but it generally assumes the possibility of a deeper and more prolonged economic decline.
2. Systemic risk: The dangers of systemic risk were highlighted by the Government Accountability Office (GAO) in its landmark 1994 study, "Financial Derivatives: Actions Needed to Protect the Financial System"(2) and were also stressed in AIG’s recent memorandum, "AIG: Is The Risk Systemic?"(3) Although systemic risk is widely discussed by analysts as a major current issue, in the Federal Reserve’s white paper, it is not specifically discussed and does not appear to be a significant consideration in the stress tests. Weiss considers systemic risk by evaluating the OCC’s measures of total credit exposure to derivatives.(4)
3. The process: In its white paper, the Federal Reserve states that the stress tests are based, to a large extent, on each bank’s self-evaluation — not only for loan loss estimates that can be derived from past data, but also for the future performance of trading accounts, which can be far more subjective. Moreover, each institution can appeal the final results, and it has been widely reported that several are strenuously negotiating for more favorable grades. In contrast, Weiss does not permit the institutions to directly or indirectly influence its evaluation process or results.
Weiss concludes: "After ringing the alarm bells of a possible financial meltdown seven months ago, and after two consecutive quarters of severe economic declines since then, the authorities would now have us believe that the nation’s largest bank holding companies can weather continued hard times. This disconnect — combined with their approach to the stress tests — denotes a lack of objectivity that can only cause more damage to the public’s confidence in the banking system."
About Martin D. Weiss
Martin D. Weiss, Ph.D., founder and president of Weiss Research, Inc., is a nationally recognized expert on financial company solvency and the author of the new New York Times Bestseller, "The Ultimate Depression Survival Guide." With more than 35 years of experience, Dr. Weiss has helped empower millions of investors to make better financial decisions through his monthly Safe Money Report and daily Money and Markets.
Dr. Weiss, along with Weiss Research analyst Mike Larson, specifically named nearly all of the major institutions that have suffered a financial failure in this crisis. Weiss predicted the demise of Bear Stearns 102 days prior to its failure, Lehman Brothers (182 days prior), Fannie Mae (eight years prior), and Citigroup (110 days prior). Similarly, the U.S. Government Accountability Office (GAO) reported that, in the 1990s, Weiss greatly outperformed Moody’s, Standard & Poor’s, A.M. Best and D&P (now Fitch) in warning of future life insurance company failures. (See the Weiss forecast track at http://blogs.moneyandmarkets.com/martin-weiss/the-only-ones-who-warned-ahead-of-time/ and the GAO report at http://archive.gao.gov/t2pbat2/152669.pdf.)
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