by Simon Black, Sovereign Man:
Yesterday we talked about how the banking system is MUCH riskier than most people are led to believe.
And there is a growing chorus of high ranking regulators and officials saying the same thing, ranging from the Vice Chairman of the FDIC to former US Treasury Secretary Lawrence Summers.
I compared the banking system to airport security. As we discussed yesterday, airport security isn’t real security. It’s merely the illusion of security.
It’s the same in the financial system.
It’s not to say that banks are on the verge of collapse. But most of these new tough banking regulations are just smoke and mirrors designed to create the illusion of bank safety.
I’ll give you a few examples:
1. Bank “stress tests” are totally useless
As part of new financial regulation, the Federal Reserve conducts annual “stress tests” of US banks to determine whether or not they will be able to withstand a financial crisis.
These tests are totally useless.
The Fed essentially throws a bunch of scenarios at the banks to see what will happen to their balance sheets if, say, the stock market crashes and GDP grinds to a halt.
This sounds like a great idea.
But what these stress tests fail to take into consideration is that in a real crisis (like we saw in 2008), just about every nightmare scenario occurs at the same time.
Markets crash. GDP goes negative. Unemployment surges. Then major institutions collapse, which causes other major institutions to collapse.
The Fed’s stress tests assume that bank failures happen in a vacuum. They don’t. When one major bank fails, it drags the other banks down with it.
That’s precisely what happened in 2008. Lehman Brothers went under, creating a financial maelstrom that nearly brought down the entire financial system with it.
Bottom line, the Fed’s stress tests are far too rosy and academic to be worthwhile. As Bloomberg’s editorial board points out,
“[The Fed’s stress test] also assumes that a thin minimum layer of equity capital — just $4 per $100 in assets — would be enough to maintain the market’s confidence in a bank’s solvency. These flaws make a passing grade almost meaningless.”
Yet even though the stress test results are pointless, the Fed publishes them as an ultimate blessing that the financial system is healthy and sound.
Once again, it’s not real safety… merely the illusion of safety.
(It’s also ironic to point out that the Federal Reserve itself is nearly insolvent and would fail to pass its own Mickey Mouse stress test.)
2. Regulations for increased bank capital are a complete joke
Many of the new financial regulations require banks to increase their levels of capital. And these rules are perhaps even more useless than the stress tests.
In banking, capital is like a bank’s emergency reserve fund.
If things go horribly wrong and their assets start plummeting, a bank with generous capital reserves will be able to stay solvent. Poorly capitalized banks will collapse.
Lehman Brothers is an easy example.
It used to be one of the top investment banks in the world. Yet died a painful death in 2008 because its capital reserves were tiny compared to its massive investment losses.
As a result, regulators started requiring banks to hold more capital.
But there are so many loopholes in these rules that banks can easily hide their true financial condition.
It’s so bad that the FDIC’s Vice Chairman stated last month that the system “too easily allows banks to conceal risk,” and that the banking system’s true levels of capital reserves are “inadequate for bank resiliency”.
3. The Volker Rule farce
This one is probably the most hilarious.
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