Stress Testing American Banks Again!

Fed Gives Banks Dire Stress Test Scenarios For 2014

Lenders including JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) will have to show they can survive the demise of a trading partner or a plunge in value of high-risk business loans in the 2014 version of U.S. stress tests.

The scenarios for the annual tests, outlined by the Federal Reserve in a statement yesterday, reflect some of the most pressing threats seen by regulators as they gauge the ability of the U.S. financial system to withstand economic shocks. Bankers will have to show what would happen to the value of leveraged loans they hold, the impact of another housing bust and how they’d fare if a firm that owes them substantial sums collapses.

 The test shows Fed officials remain concerned that banks might still rely too heavily on a single counterparty to hedge potential losses, a practice that contributed to the 2008 financial crisis.

In the “adverse” scenario, banks will be tested against global flight from long-term debt that pushes the U.S. into a recession, with unemployment rising to 9.25 percent. The yield on the U.S. 10-year Treasury note jumps to 5.75 percent by the end of 2014, and corporate bond and mortgage rates also rise.

In the Fed’s “severely adverse” scenario, the jobless rate peaks at 11.25 percent, stocks fall almost 50 percent and U.S. housing prices slide 25 percent, while the euro area sinks into recession. Developing economies in Asia also experience a “sharp slowdown,” the Fed said.

The Fed said the larger drop in U.S. house prices in this year’s severely adverse scenario is “particularly relevant for states or metropolitan statistical areas that have experienced brisk gains in house prices over the past year.”

My view:

The Federal Reserve is once again stress testing banks.  

With the economic recovery well underway, according to the media, one wonders why do the tests at all?  And the tests are rather severe if a 50% drops in the stock market and 25% drop in home prices is considered.

So the underlying, unwritten message seems to be that the Fed knows darn well that many of the officially published numbers are smoke and mirrors.

A public so heavily dependent on food stamps and part time employment, is not going to go on any spending sprees anytime soon.

The fact that many emerging markets are complaining openly about US dollar hegemony and discussing rival/alternate currencies should give us pause.

If US dollar dominance is successfully challenged over the next few years, bond yields and consequently US interest rates will rise substantially.

The privilege of massive money printing will soon disappear if a dollar challenger is successful.

Look for an attempt by the Chinese to introduce the Renminbi as an alternative compared to a weakening US dollar and Euro.  Russia and Brazil are also countries to watch as this develops over the next several years.  Gold reserves will likely play an important role in any alternative currency roll out.

In the short term, the US dollar seems to be determined to bounce a little higher, as the other currencies look just a little bit uglier.  

But, how long will the bounce last?