My new editorial on the Wall Street Journal:
Stress Tests Won’t Prevent the Next Financial Crisis:Â Expected losses under invented scenarios tell us little about risk and reality.
On March 26, the Federal Reserve will release the results of the “stress tests” it conducted on the nation’s 30 largest banks. The findings will purportedly reveal how well a bank can withstand a financial crisis, but the Fed’s decision to implement more complex stress tests doesn’t address what caused the financial crisis of 2008.
Banks are required to fund some fraction of their lending or securities purchases with equity capital, which can absorb losses. The riskier the asset, the more capital funding required under the Basel accords. The Fed then requires tests on how well a bank’s asset or investment portfolios hold up under different catastrophic scenarios…
Read the entire editorial here:Â http://on.wsj.com/1pamDLN