Column

“What you call pessimism I call realism. And I am not done yet. The stress tests assume that credit card defaults will touch $82.4 billion by end-2010, which is again not the worst-case scenario. In the old days, if the going was not good, people first defaulted on their credit card outstandings and then on their home loans. But the home loans that Americans have taken over the last few years are largely zero down-payment loans. So there is no big financial attachment to the homes purchased. This and given that home loans are non-recourse, it made more sense to default on the home loans first. But as the rate of unemployment continues to go up, the credit card defaults will go up, much beyond what has been assumed. According to Oliver Wyman, a management consulting firm, credit card losses in the US could go to as high as $141.5 billion by end-2010. In fact, most of the assumptions made for the stress test can be easily challenged and we can safely say that banks will need much more capital to survive than is being made out.”

“But, if you can punch so many holes into the argument sitting here in India, why doesn’t the US government realise all this?”

“I am sure, they do. But governments cannot always be realistic. If they had taken the real worst-case scenario, there could have been a bank run on the weaker ones. The government may have had that in mind.”

“So what do you think will happen on June 8, when these banks have to submit their plans?”

“Well, I don’t have a crystal ball, but my best guess is that banks will say they can come up with the required capital from their future income and the government will agree. Yet, as James Bibbings writes in his column ‘Stressed out’, “When they say this don’t believe it. Neither Wells (Fargo), nor the government, has been able to “anticipate the worst” in the past and this time around will be no exception.””

References: 19 Stressed Banks Must Raise $75 Billion, Addison Wiggin, May 9, 2009, www.dailyreckoning.com; Stressed Out!, James Bibbings, www.commoditynewscenter.com, May 6, 2009; Banks Brace for Credit Card Write-Offs , Eric Dash and Andrew Martin, May 10, 2009, www.nytimes.com; Credit card losses are the new bad mortgages, TraderMark, www.seekingalpha.com, May 11.2009; Wells Fargo Is Broke - Poor Forecasting Slays Another Giant, James Bibbings, www.safehaven.com, May 11,2009; America, You Have Been Outright Lied To! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario, Reggie Middleton, May 12, 2009, www.safehaven.com.