The real stress test
Seconds away… round two: It’s stress test time! I recall the run up to the first grand announcement on the outcome of putting the European banks’ balance sheets through their paces and it all boiled down to speculating on how many they could afford to fail. Too few and the test would lack credibility, too many and the markets would panic. On the day before the announcement I made a five/seven market and seven it was. Nothing has changed.
During my incarnation in the world of structured credit, we lived and died by the stress tests we applied to our clever correlation products and, surprise, surprise, they always passed. In material science or metallurgy, a fairly objective measure can be applied to both the test and the results, thanks to which most planes don’t come down until their pilot wants them to. Stress tests in the financial world, on the other hand, are not here to demonstrate where a structure will fail but predominantly to prove the point that it won’t. Enter, stage left, the stress tester’s favourite word: robust.
Even sub-prime mortgage bonds were stress tested to destruction and you know what? Robust!
It is not hard to understand that the authorities are trying to bring some order into the general panic and cynicism which is stalking the markets but the dynamics are such that they are shooting at a moving target. If they want an irrefutable stress test, they should take a sphygmomanometer around the trading floors of New York, London, Frankfurt and Paris (no sense doing that; they’re not there; happy Quatorze Juillet) and measure the blood pressure of some of the traders. Now, that’s where they will find stress and plenty of it.
There are some horrible stories stalking the Street with respect to the losses which the past couple of weeks have inflicted on trading books. One can speak to as many traders as one likes; they’ve all had a miserable time and it is not uncommon to hear stories of books which had already made their annual budget but which, in just a few short weeks, have swung from a comfortable profit to suddenly being in the red for the year. And, as usual, hand in hand with rumours of sub-expectation P&Ls come the stories of lay-offs, probable lay-offs and possible lay-offs. The dreaded redundancy fairy is fluttering over Wall Street and the City again recharging her little basket with redundancy dust. But as opposed to after the credit crisis, the prospect of rapid re-hiring the way it happened in 2009 now look a lot slimmer.
Alas, we should know a lot more after today as the first of the large US money centre banks, J.P. Morgan, reports quarterly earnings. The financial impact of the 2007/2008 crisis was softened by strong trading results which carried through until the middle of last year. Since then the environment has changed with less capital, less risk and significantly lower volumes. All the while investment banking which includes all the M&A activity hasn’t exactly been sparkling. Costs have been hard to contain as the assault on bonuses has led to higher fixed salaries and, not to be forgotten, compliance costs keep on creeping higher and higher.
The golden age of banking is over; you won’t see strikes and marches as you did by miners when their industry began contracting but the outcome will likely, with the passage of time, be similar. It is easy to forget that in the mid 1970s miners were the first workers in the UK to pass the £100 per week average pay barrier and they too were accused of being greedy. Plus ca change, plus ca reste la meme chose.
More Moody’s Blues
Meanwhile, Moody’s has stepped out of line again and put Uncle Sam on credit watch. How America can be AAA/Aaa when there is the prospect of it defaulting in three weeks’ time escapes me but I suppose the real likelihood of the default is and remains slim. However, if that very same debt-ceiling debate were taking place anywhere other than in Washington, the country in question would already be in the single-A category. Damned if they do, damned if they don’t; the ratings agencies get slammed on one hand for downgrading too quickly and then they are accused of doing it too slowly. It is easy to dismiss it all as a case of the lunatics running the asylum; it could of course also be one of the gorillas in the cage being entertained by all the human beings outside pulling faces at them.
All the while, Fed Chairman Bernanke is becoming ever more like his predecessor, Alan Greenspan, as he is turning into a three handed economist; on one hand but one hand but on one hand…. Markets rallied on his assertion that the Fed would not reverse its accommodative stance until there were clear signs of improvement in the economy and in the labour situation but then get confused when it becomes clear that QE3 isn’t on the cards but then again they see decent if not stunning corporate results. Maybe there is nothing wrong with the economy but simply with the way we measure it.