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The thing you want from a bank stress test is for the ‘stress’ to be much tougher than anything that could really happen in reality. A good kitchen-sinking, in other words.
By that standard, European stress-testing is in the toilet.
Updating something we’ve noted before: Portugal’s current five-year government bond yield is already higher than the ‘Adverse 2011′ scenario in Europe’s 2010 stress test. Last time we looked, ‘Real’ 2010 had also been a right old washout for ‘Adverse’ 2010.
Here’s the stress-test chart and the bond yields, for reference (click to enlarge):
Also better off in ‘Adverse 2011′ than in the real world — Greece, with five-year bonds yielding 14.1 per cent versus the stress-test number of 13.87 per cent; and Ireland, whose figures are 5.62 and 9.3 respectively. We have nine months of 2011 to go.
Why does this matter?
Europe’s first stress test may have been a catastrophe, but they are at least busy making a new one. Stress test II, it is promised, will include the full range of ‘extremely negative’ macroeconomic pain and specific shocks to government borrowing. (The baselines for yields will probably be drawn from what their positions on 31 December 2010, which will not make the periphery look good.)
However, we wonder how specific you can ever get, given the above.
Ireland’s five-year borrowing costs are almost double the first stress test’s figure, for instance, because few in authority were prepared for the country’s banks to tank the sovereign by the autumn (inspiring several margin calls on Irish paper). We’re seeing it again in Portugal, this time for an even more nakedly political reason, as the issue of its bailout gets kicked from one European chancellery to another. You just can’t model political risks like this, and best not to try, we’d argue.
Reigning above it all — the European Stabilisation Mechanism. We’re still not told how the ESM will approach restructuring of sovereign debt, but it’s already had a far more erratic real-life effect than anything the stress tests could really have modelled.
And we have the same European leaders who hijacked the first stress tests to thank for that, oddly enough.
Related links: Portugal, a broken debt market - FT Alphaville EU summit will skirt the real issues – FT Building a better European stress test – FT Alphaville
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