We finally got to see the results of the so called “Stress Tests” which were conducted on America’s banking system. As expected the tests marked all participants to be “solvent”, but in need of additional capital in the event that financial conditions deteriorate more severely in the future.   On the very same day that these results were released to great public applause and an enthusiastic equity market,  a largely ignored Fannie Mae press release hit the newswires which conclusively shows the Stress Test assumptions to be grossly inaccurate and dangerously unstressful.

The results of the stress tests are as follows:

_Bank of America Corp. must raise $33.9 billion. It would lose $43.5 billion on home mortgages and $24.1 billion on complex securities and derivatives deals.

_Citigroup Inc. must raise $5.5 billion. It would lose $27.5 billion on home mortgages and $22.4 billion on complex securities and derivatives deals.

_Fifth Third Bancorp must raise $1.1 billion. It would lose $2.9 billion on commercial real estate loans and $2.8 billion on other business loans.

_GMAC LLC must raise $11.5 billion. It would lose $3.1 billion on home mortgages and $1 billion on business loans.

_KeyCorp must raise $1.8 billion. It would lose $2.3 billion on commercial real estate loans and $1.7 billion on other business loans.

_Morgan Stanley must raise $1.8 billion. It would lose $18.7 billion on complex securities and derivatives deals, and $600 million on commercial real estate loans.

_PNC Financial Services Group Inc. must raise $600 million. It would lose $7 billion on home mortgages and $4.5 billion on commercial real estate loans.

_Regions Financial Corp. must raise $2.5 billion. It would lose $4.9 billion on commercial real estate loans and $2.1 billion on home mortgages.

_SunTrust Banks Inc. must raise $2.2 billion. It would lose $5.3 billion on home mortgages and $2.8 billion on commercial real estate loans.

_Wells Fargo & Co. must raise $13.7 billion. It would lose $47.1 billion on home mortgages and $9 billion on business loans.

_ Nine banks were told they do not need to raise more capital. They are: JPMorgan Chase & Co., Goldman Sachs Group Inc., MetLife Inc., U.S. Bancorp, Bank of New York Mellon Corp., State Street Corp., Capital One Financial Corp., BB&T Corp. and American Express Co.

_ The banks that need more capital have until June 8 to come up with a plan to raise the additional resources and have the plan approved by their regulators.

As an aside, we sincerely hope the efforts to raise capital include a wipe-out of shareholder equity and a transferral of common shares to bond holders.  But such justice may be too much to ask for in an environment which has grown more unjust (and un-capitalist) by the day.

Almost universally ignored by the media was an almost simultaneous announcement from Fannie Mae which gives lie to the primary assumptions made by the so-called Stress Tests, and shows the tests to be dangerously flimsy and unrealistic:

Today we learned that Fannie Mae has requested an additional $19 Billion from Treasury.  This alone would be bad enough, as it is a clear indication that with every assumption of FNM losses there seems to come an  inevitable revision to the downside.  Fannie Mae management has even come forward with an admission that their endless revisions are due to their total inability to estimate losses accurately:

“Because of the existing stress in the housing and credit markets, and the speed and extent to which these markets have deteriorated, our process for determining the adequacy of our loss reserves has become more complex and involves a greater degree of management judgment. The current state of the housing and mortgage markets is unprecedented in many respects, greatly reducing the usefulness of relying on our historical loan performance data in estimating our loss reserves.”

But the most alarming part of Fannie’s admissions is that management cannot see FNM as a profitable entity “for the forseeable future”.

Now let’s look at Fannie’s losses within the framework of the Stress Test assumptions:  The level of debt default being experienced by Fannie Mae at this time is already as bad as the Fed’s “Worst Case” scenario (twice the level of it’s “base line” or expected scenario), and includes an alarming level of defaults in “Prime” mortgages.

Since we are already at the worst-case scenario, it should be noted that there is no provision in the above capital recommendations for any scenario that gets worse from this point forward.   Remember that the banks listed above have been advised to raise capital for a hypothetical possibility that we reach the worst case scenario.   But we are already here, now. Given that we have, after only a few short weeks arrived at the supposed worst case scenario, it does not take a great mathematician to arrive at the conclusion that the worst case scenario was hardly realistic, that the banking system is currently insolvent, and that no contingency plan for a scenario worse than worst-case (ie: worse than now) exists.

Clearly these so-called “Stress Tests” were not stressful at all, and worse yet:  The recommendations listed above, which are intended to provide cushion against future defaults, barely serve to make the system solvent at this very moment, and provide zero safety margin for any increased rate of deliquency.

In our opinion, anyone who thinks that the “worst” has been priced in is dreaming.