One of my father’s favorite stories – meant to instruct as well as entertain – was about the Irish lord interviewing candidates for coach driver. He asked each, “And if the English were coming, and you had my family in the coach and had to hurry down the mountain, how close to the edge of the road would you drive?”
The first man said he’d drive as close as a yard to the drop-off below. The second man, wanting the job, said he’d drive to within a foot. The third man said, “Sure, and I’d be drivin’ as close to the mountain side of the road as I could, yr Lordship!”
The third man got the job.
This came to mind yesterday when listening to Marketplace on NPR. Tess Vigeland said, “Three hundred and forty-five thousand people lost their jobs last month. Now the pace of layoffs is slowing, but the Labor Department reports the unemployment rate now stands at 9.4 percent. Want to hear the scary part? Well remember those bank stress tests? The unemployment rate used in their so-called “Worst Case Scenario” was a mere 8.9 percent. Oops.”
That raised a flag for me, because for months unemployment has been predicted to rise to over 10 percent in 2009.
Then I read a story on Bloomberg News, Bank Profits From Accounting Rules Masking Looming Loan Losses, that included the following:
“Treasury Secretary Timothy Geithner, after “stress testing” 19 banks on their ability to withstand a worsening economy, declared in early May that Americans can be confident in the banks’ stability and resilience. Wells Fargo & Co. and Morgan Stanley were among banks raising $43 billion in new capital since then through share sales…
“… Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago, says the government stress scenarios underestimate how bad the economy may get…
“The Federal Reserve, which designed the stress tests, used a 21 percent to 28 percent loss rate for subprime mortgages as a worst-case assumption. Already, almost 40 percent of such loans are 30 days or more overdue, according to Tavakoli, who is the author of three primers on structured debt. Defaults might reach 55 percent, she predicts.”
The last “stress test” that I had involved a treadmill and a lot of heavy breathing. I was wired up with a heart monitor and under the close supervision of several folks in white coats.
It’s beginning to look like the “stress tests” those nineteen banks passed were more like a walk in the park!
How can the government claim it’s measured something – say the safety of banks – if the yardstick isn’t both (a) clearly marked and (b) open to inspection?
Almost as troubling but more obscure are some of the rules of the (banking) game that the Feds have changed recently. I remember the discussion of “mark-to-market,” but some are far more arcane. The Bloomberg article includes this:
“Along with that change [mark-to-market], FASB also let companies recognize losses on the value of some debt securities on their balance sheets without counting the writedowns against earnings. If banks plan to hold the debt until maturity, they can avoid hurting the bottom line.
“Another $2.7 billion before taxes came from an accounting rule that lets a company record income when the value of its own debt falls. That reflects the possibility a company could buy back bonds at a discount, generating a profit. In reality, when a bank can’t fund such a transaction, the gain is an accounting quirk, Weiss says.”
Such rules raise two ‘governance’ issues. First, and foremost, what are the possible unintended consequences of hurried rulemaking? Second, what is the likelihood that such rules, of obvious benefit to the industry, will ever be rescinded?
Aren’t we getting closer and closer to the edge of the mountain?