The Fed Helped Goldman Sachs, Morgan Stanley Cheat “Stress Test”

By: Tho Bishop
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Last week the Fed released the results of its regular “stress tests” given the large banks. It outright failed the US branch of Deutsche Bank which, as Thorsten Polleit recently noted, has problems so severe they could risk the whole Eurozone.

While the rest of America’s 35 largest banks were cleared by the Fed, two banks had their ability to increase stock buybacks restricted as a result of them: Goldman Sachs and Morgan Stanley. As the Wall Street Journal reported today, this outcome was the result of phone calls between the Fed and two of the most powerful banks on Wall Street. By agreeing to feeze their shareholder payouts, the banks were able to avoid their own failing grades.

As Liz Hoffman and Lalita Clozel explain: 

The arrangement—allowing the banks to keep their capital payouts level while dodging a public rebuke by the Fed—is the first of its kind in the eight years of the Fed’s annual tests and will steer billions of dollars to shareholders of both banks. Other banks in the past have been able to keep their capital payouts steady after failing the quantitative portion of the stress test. Put another way, Goldman and Morgan Stanley got the same outcome without the black eye of a formal failing grade.

It also will boost a profitability measure that helps determine how much Goldman Chief Executive Lloyd Blankfein and Morgan Stanley CEO James Gorman are paid.

While it is true that this is yet another example of Donald Trump being far kinder to Wall Street as a president than what his campaign rhetoric indicated, it worth pointing out that entire design of stress tests always had as much to do about benefiting Wall Street than it did economic stability. After all, the tests are done using the Fed’s own secret measurements, keeping useful data away from consumers to make their own informed opinions. Instead, the primary goal is for the central bank to project strength in the financial sector, which benefits banks by keeping depositors content. 

Unfortunately these stress tests have little real world value, as demonstrated by the fact that the ECB cleared 3 out of Greece’s 4 major banks shortly before they became insolvent. As Paul-Martin Foss wrote at the time:

 

If we now know that the ECB’s stress tests of Greek banks were absolutely worthless, why then should we trust the Federal Reserve’s stress tests any more?

We can only conclude that the stress tests have two purposes: 1.) to reassure the public that the banking system is safe and sound so that depositors will continue to deposit their money; and 2.) to punish any banks who fall afoul of the Fed for any reason by giving them a negative assessment after a stress test, thus tarnishing their reputation in the public eye. The former is probably more important than the latter, as the overall health of the banking system depends on the existence of deposits. Without money deposited in banks, banks cannot lend and make money. Thus, ensuring that depositors don’t flee the system is one of the primary aims of central banks and banking regulators.

Bank stress tests then are really nothing more than a dog and pony show, especially if the stress test models aren’t being made public so that their relevance (or lack thereof) can be ascertained. Rather than serving as any sort of benchmark or indicator of the health and strength of the banking system, they are yet another tool that the Federal Reserve uses to “manage expectations” – to manipulate people into believing that banks are safer and sounder than they actually are. The citizenry will faithfully continue to deposit their money into bank accounts, not once doing due diligence to see just how sound their banks actually are. And the whole rotten system will continue to lurch from crisis to crisis until its final collapse.

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