Last week Federal Reserve released the results of a Stress Test it does annually to check adverse conditions and how manageable are balance sheets of the big banks are. This year the adverse scenario contained unemployment of 10% and a GDP growth rate fall of 8%. All 23 banks cleared the required minimum.
The result estimated a total loss of $541 Bn with 78% of it coming from loan losses and 17% from trading and counterparty losses. Within the loan losses the major category contributors were Credit Card at 22% and Commercial Real Estate at 30% ( 12% domestic and 18% international ). Within this, the largest hit on absolute terms would be absorbed by Goldman Sachs.
Though these results are simulated they can provide a rough estimate of damage if any. But the problem with this is it’s the limitation to only top banks. The same adverse scenario test might bring out a very damaging picture of the Regional Banks. And it also does not account for any unrealised losses on investments that are currently in the books. For example, Bank of America has $100 Bn unrealised losses in its books.
For the time being, the stock market rally might be heating into a scenario of optimism but most of the structural issues will become more evident in the second half, especially at the end of the year. The reversal will bring in more damage than it would have when everyone expected it to happen.