Who Exactly was the Stress Testing of US Banks Intended For?

Most people are familiar with the notion that marketers believe that in marketing perception is reality. If people think they get healthier by taking a multivitamin tablet every day, even though most scientific studies prove that most, if not, all over the counter vitamin tablets have pretty much no effect, then that’s just great. You can keep on marketing these kinds of tablets to those consumers who refuse to accept scientific fact. The same goes for people who believe that they join a younger, cooler generation by simply drinking coke or smoking a Marlboro. But, sadly, while most of us are familiar with the phrase that perception is reality, most of us have missed the rest of the sentence, which is that nothing destroys a good perception than a bad reality.

In other words, if a product or service is perceived to be something it is not, and the gap between the perception and the actual delivery of the reality is too great then the repercussions could be devastating.

For some reason I get the feeling that those people who so heavily publicized the stress testing of U.S. banks also missed the most important part of the marketers’ guide to marketing perceptions. What exactly was the point of this highly publicized stress test? Was so much publicity really necessary? Pretty much everyone I spoke to in the past few weeks was asking me which banks I thought were going to fail the test. It was almost like, or perhaps even worse than, the guessing game that takes place when the latest GDP or inflation, and more recently unemployment, figures are going to be released. And, of course, while these kinds of guessing games are great to make economists feel great about themselves and their models, the reality is that no one really knows until the data is released, and even then everyone knows that the methods by which they have been compiled and calculated are incorrect. But, so long as we are all equally incorrect about how to calculate a country’s GDP, inflation, or unemployment then all is fine. The same goes for share prices. It does not matter if we cannot quantify why IBM’s shares are worth X dollars, what matters is that we all agree that it should be X dollars.

Consequently, we can be pretty sure that the model used by the people who conducted the stress test was highly questionable, even if we assume that their assumptions about the state of the economy was as realistic as they have made it out to be. Pretty much everyone knows that the assumptions for the state of the economy were the best case scenario, since the most likely scenario is certainly going to be worse than the anticipated GDP and employment figures, and the worst case would/could be much worse. It is almost impossible to use aggregate data to figure out how many homeowners who are made unemployed would default on their mortgages or credit card debts. Even in the best of times you cannot use data from previous economic environments to predict current behavior, in an unprecedented environment like today it is literally impossible.

But, of course, the data makes for interesting reading for journalists, economists, and those who actually believe these people have a clue about what is going on, and allows them all to check how many of their guesses were in fact correct. Obviously, many are interested to see just how badly banking giants like Citi and Bank of America will do if the environment used by the regulators does actually transpire.

In terms of the reality of the situation, it is good to know that the worst case scenario, at least from the FED and the Treasury Department’s perspective, is that with around $75 billion all of the major banking institutions in the U.S. would be fine. The idea is that now that we know this figure the markets can relax and be assured that the banking industry is saved. But, what difference would it have made if the figure was $500 billion. Would the markets believe that this would mean that a number of these banking giants would be allowed to fail and hence they should started selling them, causing a panic on the markets? Would international banks have stopped dealing with these banks since there is the concern of potential failure? Absolutely not. Everyone knows that whatever the number, given what has transpired till now, the U.S. government will stand behind these banks and help them until the economy is on a stable footing once again. Very few people, if any, were really worried about the number of banks that would fail the test, as many have, and the amount that would be needed to bail them out.

However, since the perception is now that the banks are reasonably safe, or at least will be with around $75 billion, then if we find that the figure is twice that all that will happen is that the perception about the value of these stress tests goes out of the window and they will have very little value in the future. What the U.S. regulators have done, in their efforts to calm the markets, is to create a perception that will certainly be destroyed by the reality. And, there really was no need for it. There was no need to make so much noise about the tests, since no one was under the impression that a bad figure would have meant the failure of a number of banks.

As they say, there s nothing more dangerous than a little knowledge, since no knowledge prevents you from making mistakes and good knowledge will help you manage them. In my mind, the U.S. regulators have done what most people with little knowledge of marketing would have done. They have only memorized the first half of the sentence, that perception is reality. Since they have overlooked the second half they might just find out too late that they have been responsible for allowing the reality to destroy the perception they have created, resulting in their own reputations becoming even worse than they are today.

This briefing is provided as general information, and does not constitute definitive advice or recommendations. Any views expressed in the above articles are those of the author concerned and do not necessarily reflect the views of Capco or any other party. Capco has not independently verified any facts relied upon in any of the comments made in any of the articles referred to. Please send any comments or queries to Shahin Shojai (shahin.shojai@capco.com). Shahin Shojai is the Editor of The Capco Institute journal (www.capco.com).