How Good is the Stress Test for Banks?

How Good is the Stress Test for Banks?

Just another example of how stupid the folks at Treasury and the Fed can be is the use of the term Stress Test to publicize the evaluation of a banks’ strength.

First, the public and only a few in the financial community fully know what each test is composed of. And secondly, the term, is a no-no because of its psychological implications with regard to the economy and the stock market.

The stress test is a poor one to start with because it is composed of too many arbitrary factors, each of which may have weightings with only indirect relativity to each other.

Of the several factors, not one by itself is of predominant importance. The ratio of doubtful residential mortgages to capital, for example, or commercial mortgages to capital, or the types of capital (what constitutes tier 1,) or loan defaults (and which types), and potential general unemployment; all add up to figures which can become too vague when experts seek decisive answers.

Some financial official or board must still make a subjective decision to act upon such stress tests. And they can be wrong, as they have been in the recent past in dealing with the financial meltdown.