Stress Test vs Colonoscopy

Treasury Secretary Geithner said last week:

"First, we're going to require banking institutions to go through a carefully designed comprehensive stress test, to use the medical term. We want their balance sheets cleaner, and stronger. And we are going to help this process by providing a new program of capital support for those institutions which need it.

To do this, we are going to bring together the government agencies with authority over our nation's major banks and initiate a more consistent, realistic, and forward looking assessment about the risk on balance sheets, and we're going to introduce new measures to improve disclosure.

Those institutions that need additional capital will be able to access a new funding mechanism that uses funds from the Treasury as a bridge to private capital. The capital will come with conditions to help ensure that every dollar of assistance is used to generate a level of lending greater than what would have been possible in the absence of government support. And this assistance will come with terms that should encourage the institutions to replace public assistance with private capital as soon as that is possible."

The metaphor of a stress test may result perhaps from some recent event in his personal life but frankly in no ways reflects what he needs to do. A stress test puts the patient under a load, increasing heart rate and cardiovascular output and then seeks to observe electrical aberrations which are reflective of blockages in normal cardiac response. There is no way he could put the patient, in this case the economy under any more stress, otherwise he will be conducting an autopsy. Perhaps the metaphor is more correctly a colonoscopy, which frankly is what needs to be done, see what is in there, for better or worse, remove the polyps, perhaps other lesions and pray for the best.

I have been examining the Balance Sheets of Bank of America and other major institutions. It is more difficult than translating hieroglyphics without a Rosetta Stone. One cannot ascertain what is good or what is bad.

Perhaps a solution is to have the market make that determination, the good old market. The Government could create a floor under the securities with a swap like structure, an insurance policy if you will, that would guarantee a bottom above zero for the packages sold. The Government does not have to buy them but merely insure them at some level, a level well less than the values transacted.

With all of the now unemployed quants on Wall Street perhaps a Draft of quants into a military like service corps would help solve the problem and instill discipline in the quants.