We’ve been critics of bank “stress tests” from the get-go, because they were a shameless misuse of regulatory credibility as a tool to prop up bank stock and bond prices. It was in some was the inevitable result of how badly financial authorities (save some lonely but prominent figures in the UK, like Mervyn King and Adair Turner) have been coopted. They honestly seem incapable of imagining a banking industry very different from the one we have now, much the less moving towards one.
The reason the US one was so successful was that the incoming Obama Administration, which was still in its honeymoon phase, threw its full authority behind it. The marketing efforts were intense; the Wall Street Journal, for instance, had front page stories virtually every day with various leaks of how the process was going.
The scathing comments of well informed critics, like former bank regulator Bill Black, never got aired in the MSM, even though journalists could not have been ignorant of his views (Black has told me that after a full hour PBS interview that took place midway through the process, in which he declared that there were no real stress tests going on, he was not contacted by a single journalist. And it wasn’t as if they were providing dissenting views via other sources).
Even though this blog and quite a few other commentators dismissed the stress tests as mere window dressing, they did have at least require banks that came up short to raise equity, and if not in the markets, via being force fed by Uncle Sam. The boosterism worked, and lots of banks sold stock quickly enough on the bank rally (also goosed by phony accounting, which was derided by Meredith Whitney but hailed by Mr. Market) to make the entire exercise look to be a rousing success. Of course, some wee problems went uncommented on. For instance, the Treasury insistence that the banks were in rude health meant that all the back door subsidies meant to rebuild bank balance sheets on the sly, the biggest being super low interest rates, led to strong earnings that were not retained, but walked out the front door in the form of record 2009 bonuses.
The European version of the stress tests was a cynical, lame copy of the US version. The Treasury effort at least had the appearance of rigor and enough media hooplah and bank grumbling to fool a lot of people. The Eurotests were done far too quickly, and perhaps more important, it was patently obvious the results were pre-ordained.
Our favorite commentary, which illustartes why you can’t have meaningful tests when no one is premitted to fail, comes via Saturday Night Live:
So now the Wall Street Journal gives us an update on the predictable outcome. Having started out with a dubious brand proposition, the sham version of a test, and having made abundantly clear in the half-assed Euromarket version what a canard it was. Not only did it assume far unrealistically low haircuts on bank sovereign debt exposures, but a mere six months later, two big Irish banks absurdly given a clean bill of health are now on the ropes.
The Euroauthorities have a new iteration of the exam due to be performed in early 2011. But now the contradiction of aims, meaningful assessment versus con game, is now in the open. And so the various national banking authorities are squabbling: do they have the results be public, as before, which will assure a pass/pass grading system? Or, mirable dictu, do they take the evaluation seriously this time, which means results must be kept secret? Oh, but that means Mr. Market will not be happy!
Key excerpts from the Journal story:
European officials are planning a new round of bank “stress tests” designed to be more rigorous than last summer’s widely criticized exams, but the effort is already beset by squabbling and the possibility that the test results won’t become public….
On Tuesday, a European Union official for the first time publicly acknowledged problems with last summer’s tests. “There was some variety in terms of rigor and application of these tests,” European Economic and Monetary Affairs Commissioner Olli Rehn said in Brussels…
Liquidity, which banks use to finance their daily operations, recently has emerged as the Achilles’ heel for a number of European lenders. Banks perceived as risky are seeing jittery customers pull out their deposits, and risk-averse investors are shunning such banks in the bond markets. Such liquidity squeezes can topple even relatively healthy banks or require taxpayer bailouts.
Yves here. Notice how no one is prepared to admit that solvency is the real problem? And the political wrangling is not trivial:
EU lawmakers in Brussels last summer signed off on the creation of three pan-European regulatory authorities, including the EBA, to replace the existing committees of national supervisors across the continent. Those committees have been relatively weak because they lack specific powers and are often hobbled by squabbling among their members.
The EBA, by contrast, will be authorized to craft binding rules that will apply across the EU. It also will have the power to mediate disputes between regulators in different countries.
Even before it gets off the ground, the EBA is encountering turbulence. Its launch, originally planned for Jan. 1, is being pushed back by at least a few months. It only recently posted advertisements seeking a new chairman and executive director, and hiring of other top officials is on hold until those positions are filled.
Complicating the process, the EBA is allowed only to hire employees who speak at least two European languages, one of which must be English.
Kay Swinburne, a U.K. member of the European Parliament, said she is “furious” about the bilingual requirement, which she fears will disqualify some U.K. regulatory officials. “Most expertise comes from London,” where many speakers aren’t fluent in a second language, she said. “Even just a simple thing like a language requirement limits the pool” of possible staff….
More worrisome to other experts is that the EBA’s structure will remain vulnerable to squabbling among countries. For example, the design of the next round of stress tests will be subject to a majority vote among EU members. Other issues, including the writing of rules and standards, will have to garner a two-thirds vote. That could prove to be a hurdle on controversial issues.
This process looks likely to make for good theater and bad outcomes.