Friday, May 8, 2009

The Stress Tests Part I

Yesterday the Federal Reserve issued the stress test report. This is all I'm going to write about today because it's really important news. But before we get to the results, let's look at the actual stress test used by the Fed to see what the basic scenario was.

Let's start with their GDP assumptions. Here is the chart of their baseline and more adverse GDP projections:

I'm assuming that "4 quarter percent change" is the same as year over year percent change. Notice the economy is already performing worse than expected in the GDP stress tests.

The current unemployment rate is more in line with the worst case scenario

The Fed's worst case scenario of home prices assumes a 22% year over drop this year. That is -- in December of this year prices will be 22% lower than in the 4th quarter of 2008. Prices are already falling at a roughly 18% year over year rate in February. Lots of people were excited when the Case Shiller number didn't set a record low in the latest report.


GDP is already performing more poorly than the Fed's stress test.

The worse case scenario for unemployment is the most realistic possibility.

Home prices are already closer to the Fed's worst case scenario than the median baseline forecast.

Bottom line: the worst case scenario is the most realistic scenario.