Bond markets give stress test thumbs down

May 8, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

The most revealing verdict on the results of the U.S. banking stress test was delivered not by shareholders but by the vigilantes of the bond market, who shunned an auction of 30-year government debt.

This makes sense: if the U.S. is letting banks off too lightly it will be taxpayers and the people who lend the U.S. money who will have to pick up the bill.

The stress test, which showed that 10 large banks will need to raise about $75 billion in capital, was greeted with euphoria by bank shareholders, despite being heavily leaked.

That’s no surprise, the stress test is useful not so much as a set of forecasts about the economy or bank losses, those being arguably too optimistic, but as a signal from government to capital about the rules of the game. It matters not because it is true but because of who is saying it.

Think of it as a term sheet in which the U.S. seeks junior minority investors to take some of its exposure to its banking system. The message is we will give you enough rope to try to earn your way out of your hole; if it works the rewards will be huge.

The U.S. has already said that none of the 19 banks would be allowed to fail, and if the past year has taught us anything it is that banks are creatures of government, the corollary being that that government has to pick up the pieces if banks fail.

So how do we interpret the very poor debt auction, or the fact that 30-year bonds ended the day yielding about 25 basis points more than in the beginning, a very large move when yields are only a bit over 4.3 percent?

It’s possible that this is a green shoots story, that bond market investors are looking for a healthy pick up in growth and inflation, but I doubt it.

More likely is that it is a combination of unease about budget indiscipline, about the amount of debt the U.S. will have to sell and about the bills that will come due if the stress test gets an F from reality.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.–


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The bank stress tests are a total waste of time and the Bond market knows it. The banks are basically insolvent and that is why the mark to market rules were changed. The markets know it is a con but are going along with it for the time being. Being cynical, the idea is for the stock market to rise and pull the retail investor in, it will then fall leaving them with huge losses. It is a bear market rally and it, along with the green shoots are a total sham. It is going to get much much worse and the Bond market knows it.

Posted by D Rumsfeld | Report as abusive

Of course it’s a sham. They want the consumers to invest and purchase so that the economy will get back on it;s feet. It’s just like telling you that the economy is starting to turn around, the sun is shining, and you should get back out there and spend your money. I don’t know where they think it’s better, of couse if your making a huge salary, or have been given your huge bonus thanks to the OBAMA bailout program, it probably won’t affect you as much. What about all the people who now, because of their lost investments, can’t retire, or all the people who have been laid off. The smart investment is to keep your money in your pocket, that’s where mines going to stay….

Posted by RD Low | Report as abusive

The green shoots ARE there… just not in the usa.
The usa has been fatally damaged and just as the OECD is predicting the UK will leave recession (or is leaving recession now!) FIRST ahead of anywhere else in Europe, on the back of buoyant China, rising Indian and a crawling Europe.
This leaves the stagnating usa, as expected, dead in the water and telling itself “everything gonna be alright and everywhere else is having it worse”.
The dollar can only crumble from here, as money leaves US Treasuries and heads for someplace money can be made, such as recovering, rising equities.
This, finally, will expose the damage done to the greenback as this tide goes out and every commodity imported into the usa will rise, not because of demand but because the weak dollar will buy less of it…
QED the usa is doomed for at least a generation!

Posted by David H Parry | Report as abusive


I too love a good melodrama, but IIRC, Germany and Japan were bombed into oblivion, yet did not require a generation to re-build. How is it that a country with less national debt per head of GDP than the average OECD country will have a worse fate.

As depressing as this decade will turn out to be, and yes the dollar will eventually decline, but much slower than dollar cynics would have us beleive. For one, the Dollar is a global store of wealth and a key medium of exchange for trade. Therefore, the same sort of counter-reality dynamics we see by Governments with regards to tackling the financial system, will also be applied to dollar decline denial. I sense plenty of schadenfreud from Europeans on these comment sections.

The issue is the extent to which the government will kick this can down the road, and socialise the problem wider and deeper, but over a longer period of time.

Posted by nyongesa | Report as abusive