Most people questioned the viability of the “Stress test” performed a few months ago. What was the standard used and how realistic was the Federal Reserve in the estimates used. Turns out a big factor in the test was unemployment, and thus far, the unemployment numbers are significantly worse than what was expected as a “worst case scenario”

Take a look at this graph Calculated Risk put together:

Now U.S. regulators are waking up to the fact that “woops, we messed up” and are suggesting yet another stress test.

In a report released Tuesday, the Congressional Oversight Panel for the government’s $700 billion financial rescue effort found that the Federal Reserve used a “conservative and reasonable” approach to assessing the health of the nation’s biggest banks.

But, the panel added, the Fed’s worst-case scenario does not go far enough. For example, the “stress tests” conducted by the Fed were based on the 2009 unemployment rate average of 8.9 percent. Unemployment in May climbed to 9.4 percent.

“While no one should gainsay the potentially positive results of the tests, it would be equally unwise to think that those results reflect a diagnosis of all of the potential weaknesses or create a necessarily sufficient buffer against future reverses for the banking system,” the panel wrote.

Now, here is my big question – if banks are all of a sudden able to pay back their TARP loans, and the financial sector is no longer in collapse (as the Fed would want us to believe), why is it the government is pushing for another stress test?

How about a poor earnings across the S & P and this is a proactive measure. Maybe. What about regulators simply doing their job. Possible. Could it be that the economic situation is much more dire than anyone is willing to admit? Likely.

Since the announcement that the federal government was going to perform stress tests on the nations 19 largest financial institutions, economists questioned just exactly would that mean?  What was going to determine if a bank was “strong” or not, and if not, what action was going to be taken.

Well, it turns out that the real findings of the stress test may not be know… and what the general pubic is viewing, in terms of results, is a negotiated – seemingly random number – developed by the banks and the government.

Take a look at this via the Wall Street Journal:

When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of AmericaCorp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed’s exaggerated capital holes. A senior executive at one bank fumed that the Fed’s initial estimate was “mind-numbingly” large. Bank of America was “shocked” when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks’ ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.

…

The Fed ultimately accepted some of the banks’ pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter. 

Bank of America’s final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.

A Bank of America spokesman wouldn’t comment on how much the previous gap was reduced, though he said it resulted from an adjustment for first-quarter results and errors made by regulators in their analysis. “It wasn’t lobbying,” he said.

Wells Fargo’s capital hole shrank to $13.7 billion, according to people familiar with the matter. Before adjusting for first-quarter results and other factors, the figure was $17.3 billion, according to a federal document.

“In the end we agreed with the number. We didn’t necessarily like the number,” said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed’s assumptions about Wells Fargo’s revenue outlook.

The financial institutional that faced massive losses over the last six months didn’t like was was said about them, and their ability to provide capital for operations, so what do they do?  Complain to the federal team who, for a lack of better terms, was auditing them. And their complaining got them what?  Numbers that are more favorable to their business operations.

Just so I understand.. the government was to do a test to determine if a bank was financially sound, once performed it turned out that a bank was not and additional funding was needed.  Offended, the bank put up a stink and the government changed their findings to be more favorable to the bank.That is like me saying “I don’t like the C+ I obtained while taking my masters level mid-term, I want a B” and the teacher simply giving it to me simply because I asked.

If that is NOT a sign that the stress tests performed on the U.S. financial institutions are meaningless, I don’t know what is.

At 5:00 PM this afternoon, the bank “stress test” results were published.  From the looks of it, a number of banks need significant amounts of capital (originally posted at Calculated Risk):

Once you look past the fact that roughly $75B more is needed, one has to ask “what does this really mean?”

I’m afraid to say that the results may mean nothing.  Yes, $34B for Bank of America is a boat load.  Same goes for the $15B Wells Fargo and $11.5B for GMAC need, but what if the additional funding does not help in the long run?  I ask this question simply because there is significant doubt around the credibility of the stress test results.

The assumption the test is based on is that these 19 financial institutions could potentially face another $600B in losses under “the worst conditions” but what if it’s more?  What if there is another $1.2T in losses? Will the banks be able to turn to the private markets in order to raise capital, as Wells Fargo is already saying they will do?  Would the investment community continue to throw money down the hole, or would Uncle Sam need to act as backstop once again?

I still believe the worst is yet to come.

If you take a quick trip down memory lane you will recall there was significant debate as to releasing the bank stress test data.  When will the government?  Should the government?  How will they do it?  

You get the point.

Anyway, the data is due to be reported this week and the information that is leaking out seems to be a bit disturbing – 10 of the 19 banks will need to raise capital.

The U.S. is expected to direct about 10 of the 19 banks undergoing government stress tests to boost their capital, according to several people familiar with the matter, a move that officials hope will quell fears about the solvency of the financial sector.

The exact number of banks affected remains under discussion. It could include Wells Fargo & Co., Bank of America, Citigroup Inc. and several regional banks. At one point, officials believed as many as 14 banks would need to raise more funds to create a stronger buffer against future losses, these people said, but that number has fallen in recent days.

Looking a bit deeper into the news that is in the press, the really disturbing information starts to find the light of day:

Bank of America Corp(BAC.N) has been deemed to need as much as $34 billion in additional capital, according to the results of a government stress test, a source familiar with the results said on late Tuesday.

Bank of America spokesman Scott Silvestri declined comment

Remember that Bank of America was considered to be surviving institution.  While the acquisition of Merrill was significantly more difficult than expected, the government had already provided support due to the situation.  

If the information out now is to believed, and Bank of America does need an additional 34B, what does that mean for the financial institutions deemed at risk, such as Citibank?  Better yet, what does it mean for the “solid” companies such as J.P. Morgan or Wells Fargo. 

The data release date is on 5/7… it will be interesting to see how the market reacts.

If one listens to the press, all of a sudden the economic world that was in total free fall all of two months ago is suddenly not that bad.  So, which is it?  Is the world on the verge of total economic collapse or are we all living in a world where we just might make it out alive.

I don’t know, I’m not an economist, but I will point out a few things and let you decide.

Foreclosures continue to rise while property values continue to plummet.  Not fall, plummet.  Some areas of the nation are seeing property values falling by nearly half.

Bank or America, JP Morgan Chase, Goldman Sachs and Citibank have all reported better than expected results but there is significant discussion on how and when to release the bank stress test results.  Doesn’t that seem odd to you?

Both California and North Carolina have record unemployment

General Growth Properties, the second largest shopping mall operator in the world, declared bankruptcy due to unmanageable debt and a loss of contracts.

Venture Capital investments are at their lowest in 12 years, this means new ideas are now being fueled… new businesses are not starting….

The US has lost 4,197,371 jobs since February 2008 and the layoffs continue in waves

For some reason Ben Bernanke sees positive signs in the economic situation and is “fundamentally optimistic” about where we are doing.

So, what do you think?

Maybe Bernanke and company is looking at information unavailable to the rest of the public but all that I see is negative.  I want to see true signs of recovery, I want to see that the nation – and the world – is turning around but I simply don’t.  I simply cannot believe that things have turned for the positive.  If the banks were strong – truly strong – the stress test results would be released without debate as to how to do so.  If things were bottoming – let alone growing – the layoffs would not be continuing at such a large clip.

Bottom line, for me, I think the worst is yet to come.  GM and/or Chrysler will go into bankruptcy, major banks will go under or be nationalized, and unemployment will continue to rise – I still believe 10% is going to happen this year.

So, what do you think? Am I missing something?