Page 35 - Accelerating out of the Great Recession

ACCELERATING OUT OF THE GREAT RECESSION

holders and bondholders lose (some part) of their investment, and
taxpayers get the option to claw back some of their money, after
successful reorganization and reprivatization have taken place.
So governments typically have opted for a fourth way—
muddling through. They have dabbled in asset purchases or
guarantees and pursued a bit of recapitalization. Mainly, how-
ever, they have relied on making money available at very low
rates of interest, allowing banks to earn good margins. And they
have crossed their fingers and hoped that the economy will
improve enough to pull the banks back from the brink.
For an example of muddling through, we need look no fur-
ther than the “stress test” applied by the U.S. government in the
spring of 2009.
What was the methodology? The government used a model
that predicts the losses of a bank as a function of macroeconomic
factors: GDP growth, unemployment, and the change in home
prices. This was fairly logical. Next, they developed a scenario for
how each factor was likely to evolve, starting from a baseline,
deteriorating at first, and then slowly improving. After that, they
created what they called the “stressed” scenario—a characteriza-
tion of the worst case. And finally, they applied the stressed sce-
nario to the actual income statements and balance sheets of each
of the 19 banks that were to be audited.
This all sounds reasonable, but there was a catch. The scenar-
ios were based on forecasts that were wrong. When the stress test
was performed in May 2009, several reputable forecasts were far
more pessimistic than the “stressed” scenario assumed by the U.S.
Federal Reserve. For instance, in the baseline scenario, the Fed
assumed –2 percent GDP growth in 2009 and 2.1 percent growth
in 2010. The “stressed” scenario assumed –3.3 percent in 2009 and
0.5 percent in 2010. Remarkably, the annualized and seasonally

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