Federal Reserve Stress-Testing Model Error–Nom de Plumber’s Thought of the Day

ndp   Nom de Plumber is a Nom de Plume

———— http://www.federalreserve.gov/newsevents/press/bcreg/DFAST_2013_results_20130314.pdf

In these tests of bank capital adequacy under a severely adverse economic scenario,
the projected losses for second-lien residential mortgages and HELOC’s would generally be less than 10% of principal balances.   (See Table 5 in CCAR report).
That would be strangely lower than the actual default losses of first-lien Prime, Alt-A, and even some Agency mortgages during the current crisis.

This odd result for a major asset category at “systemically important” banks might challenge the perceived validity and stringency of Federal Reserve stress modeling.

Reliance upon these benign stress-tests may lull the regulators who built such models
into a false sense of security.

Thank you.

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