Unemployment could jump to 13%, recalling the breadlines of the 1930s. The Dow Jones industrials might plunge 50% to 5,668, a level last reached before the dot.com boom in the mid-1990s. Output might shrink at an 8% annualized rate, wiping out two whole years worth of growth. And anyone lucky enough to have a job or cash left after the carnage could snap up a home at November 2000 prices.
Stella Dawson reports for Reuters, Nov. 23, 2011, that the dire picture is what the Federal Reserve wants U.S. banks to imagine when they test their balance sheets for resiliency against a major economic shock.
(A recent Zogby Poll found that the percentage of U.S. adults who believe it is possible for themselves and their families to achieve the American Dream has dropped to 50%, down significantly from the 68% who said the same in November 2008.)
The Fed last year began running banks through annual “stress tests” to measure how their balance sheets and capital buffers would cope with conditions in the consensus economic outlook, plus a major shock. On this past Tuesday, it announced details of how it will conduct its round for 2012 release.
The dire picture painted by the Fed sounds shocking, but it’s based upon actual experience of severe recessions, such as 1973-75, 1981-82 and the firestorm that swept through the United States after the shock bankruptcy of investment bank Lehman in September 2008, which ushered in the worst recession since the 1930s.
Next time around, however, damage could be even worse because the U.S. economy would enter in a weakened state. It is still healing from the last recession and a second blow could be crippling.
The Fed also notes risks from overseas. “An outcome like the supervisory stress scenario, while unlikely, may prevail if the U.S. economy were to experience a recession while at the same time economic activity in other major economies were also to contract significantly,” it said.
If the United States were to enter a deep recession in the fourth quarter of this year, the Fed’s worst-case scenario envisages the euro zone hit hard, suffering almost two year’s of contraction until mid-2013, while output shrinks by a more than 6% annualized rate at its depths.
Few economists predict a U.S. recession, though uncertainty is rampant. A Reuters poll earlier this month put the risk at 25%, down from 30% the prior month, and recent U.S. economic data has slightly improved.
The Fed’s latest stress test is tougher than the last — little wonder, noted Nomorua Equity Research, given Europe sliding back into recession, China slowing, financial markets in turmoil over the euro-zone sovereign debt crisis and an uncertain U.S. fiscal picture.
But Richard Bove, a banking analyst at Rochdale Securities, says it is irresponsible to put 31 U.S. banks through a worst-case scenario. A stress test this tough risks forcing banks to prepare for the worst, possibly creating what regulators fear.
Bove told Reuters Insider Television: “This is a really stupid stress test. They [banks] are going to dump loans, they are going to stop lending and they are going to put us into the recession that the government wants to know how they will function within.”
Srinivas Thiruvadanthai, director of research at the Jerome Levy Forecasting Center, disagrees. He welcomed the Fed’s move, saying it will hasten a shrinkage of bank balance sheets that is much needed to match a slower-growing economy.
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