The Banking Industry Stress Test

The Federal Reserve yesterday made public a portentiously titled document about its ongoing examination of all those troubled investment banks you've been reading about.

The Fed's paper is called "The Supervisory Capital Assessment Program: Design and Implementation."

Read it for yourself here.

Or take my word for this concise summary. The Fed and other regulators have been looking over the records of the banks with an eye to determining whether they could survive the next bad thing that might happen to them, "a recession that is longer and more severe than the consensus expectation."

The idea, apparently, is that if the Fed does this stress testing and then triumphantly proclaims that the US banks are now in great shape, able to handle whatever economic reality may throw at them over the next two years, potential equity investors and counter-parties will cheer up and the engines of commerce will start to hum again.

There is a lot that is dubious in that reasoning. But I have to say, I find the name of the program funny. Supervisory Capital Assessment Program? SCAP? Why not make it the Supervisory Capital Recovery Assessment Program? Oh ... sorry ... I just realized they are no doubt saving that name for an assessment of the US auto industry.

Anyway, there was a neat public argument over this program on CNBC yesterday morning, puitting Rick Santelli against Steve Liesman. Rick Santelli, you may remember, helped inspire the whole "tea party" thing with a much-viewed soliloquy on mortgages, bail-outs, etc.

The clip to which I'm about to link you starts in a rather pedestrian way. Santelli gives his usual morning report from the trading pits. Feel free to skip forward to about 3:15, when things get more interesting. The pundits in the studio are talking about the saying "most people think they're above average" and what it may mean in terms of the upcoming stress test announcements.

Then at about 4:15, Santelli jumps back into the discussion, and it gets hot between Steve and Rick, with each accusing the other of not understanding how the banking system works.

Interesting question from Liesman. "You are a local official on the banks of the Mississippi, deciding how high the levy should be. How great of a disaster do you want to prepare for, a 100-year flood? a 500-year flood?"

The point of course has to do with how stress tests should work (what is a "worst case scenario" exactly?) and how banking capital reserves should be set.

Rick gives a good philosophical answer to that question, but Steve thinks it misses the point, and wants to try to get Rick to think inside the box, if you will, of the existing social/political/regulatory system. "Reality not your imagination," as he puts it. Then things go amusingly down hill into shouting match territory.

A stress test for the vascular system of both men, perhaps?