foreign Exchange rates

How About Those Stress Tests…


What’s the deal with those stress tests? It sounds like the setup for a Jerry Seinfeld joke, and given the way the tests were viewed by the markets, it might as well have been. According to the EU, the tests were a tremendous success. According to investors, the results were irrelevant at best, and patently misleading at worst.



The stress tests were first proposed last month as a way to gauge the health of the EU banking sector; it was hoped that the results would demonstrate the soundness of the banking system and mollify investors. Since then, momentum continued to build in the markets, as investors engaged in meta-speculation about the potential impact of the stress tests.


When the news was initially released, the Euro sea-sawed – first rising, then falling – and analysts rushed to ascribe sometimes-contradicting sentiments. First, there was “concern,” then came “relief.” From where I was sitting, the markets’ reaction was basically somewhere between a shrug and a yawn. First of all, investors saw the tests for the charade that they essentially were. The only reason that EU regulators were willing to conduct them publicly was because they knew that the results would be positive. As I wrote above, it was intended in advance that the tests would “mollify investors.”


In fact, that test could come quite soon, as the ECB continues to recall the hundreds of Billions of Euros in loans that it made to commercial banks. If LIBOR rates remain steady and the markets remain liquid, then the stress tests can be called a success. If private investors balk and/or the ECB is forced to extend its lending program, however, the tests will be seen in hindsight as a waste of time.