Following Spanish and German leadership, the EU announced on Thursday it would publicly release the findings of EU bank stress tests.
The debate over the findings' release overlooks the fact government stress tests are mostly futile with very little upside.
Ironically, while the EU is attempting to determine the health of European banks, they also announced they'd push for a G-20 bank tax.
Banks are vastly healthier today than during the height of the financial panic, but the industry still faces headwinds.
Following US precedent, the EU has for weeks been undertaking a series of bank stress tests—but unlike the US, they had no plans to release the results. Of late, debate over the issue "to release or not" has been hot and heavy. US Treasury Secretary Timothy Geithner urged the EU to change course and release the results to assist the public in risk assessment. Thursday, following Spain and Germany's lead, the EU complied and announced results will be made public. The decision was widely expected—as German Chancellor Angela Merkel put it, not announcing the results would give the appearance banks and regulators have "something to hide." Increased transparency is generally good for investors, though this debate overlooks the bigger issue: Governments using a random set of criteria to forecast the future is mostly futile and can have unintended consequences.
The US version last year was fraught with folly. Abominable communication from the Treasury initially about test details contributed to massive uncertainty about the fate of the US banking system, Financials underperformance, and stock market volatility. Even the tests themselves were flawed—the "worst case scenario" proposed in the test used metrics some argue were watered down. For instance, US unemployment reached a higher point than in the tests—which didn't seem to stress banks very much in reality, considering the whopping profits recorded since. Perhaps such tests marginally improve transparency, but we're doubtful. Governments have a long history of being rather poor evaluators of risk (tragically illustrated again by the Gulf oil spill). Test results could force firms to unnecessarily raise capital or convey a false sense of security by convincing folks a bank is safe no matter what conditions follow. Ironically, while the EU reviews European banks to determine their health (or lack thereof), they announced Thursday they'll push for a G-20 bank tax. If bank health is in question and requiring tests, then why push for a measure making banks less healthy? Beating up on banks now because it's politically easy is a counterproductive trend that's unfortunately globally popular.
It's another example of continuing headwinds for Financial stocks, but for the broader market, this is widely known and holds little surprise power. US stress test results didn't stand in the way of a young bull market, and the EU version seems highly unlikely to stem off the still-young bull now.
On the contrary, in the immediate term, uncertainty surrounding stress tests may be one factor contributing to the global stock market correction and the even steeper drop in many EU countries, so resolution of the much-anticipated tests could provide investors with a measure of relief. Additionally, with the strong profit power of a steep yield curve, revisions to misguided US mark-to-market accounting standards, high profitability in recent quarters, and strengthened balance sheets, banks in the US and Europe are far healthier now than during the financial crisis, and getting more so. Those are much better metrics than a pop quiz of hypothetical conditions administered by politicians.
Whether across the pond or here in the US, governments seem to have a real knack for learning the wrong lessons from history (even one-year-old history). While it would be refreshing to hear politicians step up and admit that fact, we're not holding our breath. In this case, it's a plus that the wrong lesson learned is to conduct mostly futile stress tests on banks that are, by and large fine, and not something worse.