No Laughing Matter

European regulators released the results of their stress tests of European banks.The report indicated that seven banks failed the stress test. None of the banks are large institutions with significant numbers of individual U.S. investors. Two of the banks, Hypo Real Estate Bank of Germany and ATEbank of Greece have already been nationalized making the test and its results moot in their cases. By and large the test was considered a joke, but no one should be laughing.

Only sovereign debt exposure held by trading areas of the respective banks were counted. sovereign debt held at other parts of the banks and other risky or potentially risky assets were not counted. German banks, which initially balked at the prospects of a stress test, participated, but did not publicly reveal their sovereign debt exposure. Anyone who is comforted by the results of the European stress tests are immaturely optimistic or have questionable mental faculties. The test does little to determine whether or not European banks could withstand a severe shock to the financial system.

The 84 banks which did "pass" the test reportedly proved they could maintain a Tier-1 capital ratio of at least 6%. Tier-1 capital includes cash reserves (including deposits), common and preferred stock and certain hybrids.


The equity markets recovered and bond yields have risen during the last two trading sessions following a portrait of modest growth painted by Fed Chairman Bernanke. Equity markets are responding to good earnings (such as Ford which as recovered by trimming capacity and unnecessary jobs) and the treasury market is pricing in a modest recovery.


I have been of the opinion for some time that the recovery would be modest and the trends of the past two decades no longer apply because we haven't had an economy that was permitted to function without headwinds (Great Society spending of the late 60s / early 70s) and then constant stimulus (Volcker through Greenspan). Here is what an economist from a major Wall Street firm had to say:

"The secular bear and bull bond markets of the past 50 years have been largely a reflection of the Great Inflation of 1965-81 and the unwind that resulted when the Fed recaptured its independence and commitment to price stability. Current super-low bond yields reflect a combination of that complete adjustment overlaid on a cyclical
low point in income."


Sorry technical guys, the game has changed. Trends just don't happen. Trends occur because people make them happen with policies and sentiment.