Stress Test: All Just a Publicity Stunt

| About: SPDR S&P (KBE)

Neither the Government, the senior management of the big banks nor the investors need a Stress Test to determine the financial status of the banks. Treasury and Fed investigators have been inside of the big banks for months now. The heads of the banks know where they stand as well. As for the market, it has long ago figured out that the Financials are in big trouble. In spite of the recent bounce back in stock prices, Citi (NYSE:C) is still trading under $4. The market, as always, speaks for itself.

The Treasury Stress Test has only one real purpose. It was/is a publicity effort. It was supposed to demonstrate to the broad public that:

The folks in Washington are on top of this. They are going to take a hard look. Those banks that are not 'up to snuff', they will fix. The other banks will be just fine.”

This publicity effort could flop. Treasury and the whole Stress Test process got a slap in the face in just the past 24 hours. Tuesday we got this:

Yesterday we had this news:

The downside assumptions used to stress test the banks for 2009 include:

*A drop in the Case/Shiller Ten City housing index of 22%. The starting point for the index was set at 162. The ‘worst case’ twelve-month drop would bring the index to 127.

*A drop in GDP of not greater than 3.3%.

*Unemployment to remain less than 8.9%

We are off to a terrible start with the assumptions used in the tests versus the recently announced statistics behind those assumptions.

The Case/Shiller home price report Tuesday showed a drop of 2.1% for February. This followed a drop of 2.6% in January. As of the end of February, the index has fallen by 8 points in just the first two months of the reporting period. At the present rate of decline it will reach the Treasury’s down side target in September. On an annualized basis the two-month drop is significantly above the 22% benchmark set by Treasury.

The GDP report showed an annualized loss of 6.1%. Almost double the rate of decline used to test the banks. While there may be some green shoots around there is also a swine virus that will certainly dampen consumption in the coming months. Even if the economy stabilizes it will be difficult to get out of the first quarter hole. The 3.3% ‘downside’ will likely be exceeded based on the 1st quarter GDP report.

It is possible that the pace of the declines in housing prices and GDP will slow in the remainder of the year. That remains to be seen. What is clear is that the economy is currently performing significantly below the conditions under which the banks are being tested.

If the upcoming payroll report shows another significant jump in unemployment (it will) then all three metrics that Treasury has used to measure the viability of the banks will have been exceeded.

As these statistics are revealed and the economic implications of the numbers are felt by individuals the inescapable conclusion will be:

The DC folks told us that the banks were okay provided things did not get worse than such and such. Well, things are much worse than that and therefore it must mean the banks are not safe. If the banks are going bust then I might as well stop paying my mortgage.

Publicity stunts rarely work. It is unlikely that the Stress Test will prove an exception.