March 18, 2012 7:34 pm

There is no Spanish siesta for the eurozone




The markets have concluded that the eurozone crisis has ended. Several politicians said that they, too, believed that the worst was over. Complacency is back. I recall similar utterances in the past. Whenever there is some technical progress – an umbrella, a liquidity injection, a successful debt swapoptimism returns.

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If you think the European Central Bank’s policies have “bought time”, you should ask yourself: time for what? Greece’s debt situation is as unsustainable as ever; so is Portugal’s; so is the European banking sector’s and so is Spain’s. Even if the ECB were to provide unlimited cheap finance for the rest of the decade, it would not be enough.

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In Spain, most of the toxic debt is held in the private sector. The debt level of the private sector, namely households and non-financial corporations, was 227.3 per cent of gross domestic product at the end of 2010, according to Eurostat. Last year’s data are not out yet, but the number will be down only a little. One of the areas where adjustment is happening is in the housing market. The best index for Spain is the new series by the National Institute of Statistics, which shows the overall index for house prices fell by 11.2 per cent last year alone, but was only down 21.7 per cent from the peak in the third quarter of 2007. We should remember the Spanish bubble was much more extreme than others, but prices have only come down by around a fifth. In the Madrid region the movements have been more vigorous, with a peak-to-trough fall of 29.5 per cent.



On my estimates, Spain’s house price adjustment is still less than halfway complete. In real terms, the US housing boom has been almost completely cancelled out. The graphs of historic bubbles, if expressed in real prices, have nice bell-shaped curves. This makes sense, since domestic property is an unproductive real asset. In Spain, as elsewhere, it would be reasonable to assume real prices will eventually fall to where they were in the mid-to-late 1990s.



The Spanish government has forced the savings banks to write down €50bn in their property portfolios this year. This will only be a small part of what will ultimately be needed if the housing market falls as I expect it will.


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Official estimates assume mild price falls and a quick rebound in the economy. Both assumptions are delusional. How can the Spanish economy rebound if the private and the public sectors are deleveraging at the same time, and are likely to do so for many years?


The deleveraging of the public sector will be vicious. The deficit was 8.5 per cent of GDP last year. This was a big overshoot, but the reason was not fiscal indiscipline. It was necessary to avoid a bigger slump.


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The recently-revised target is 5.3 per cent for this year and 3 per cent next year. So the total public sector adjustment needed under the European deficit rules is an incredible 5.5 per cent over two years – this, in the middle of a recession. If you look at the extent of total deleveraging that lies ahead, in both private and public sectors, the question is not whether the Spanish economy rebounds in 2012 or 2013, but whether it can rebound at all before the end of this decade.


The typical European response to the last statement would be to say that economic reforms will increase confidence and produce growth. The optimists point to Italy, where the appointment of Mario Monti as prime minister has led to a seemingly virtuous circle of reforms and lower market interest rates. The main reform in both countries has been a moderate relaxing in labour laws. While that is probably necessary, I would be surprised if this has a material impact on long-term growth rates. Large parts of the labour market literature would have to be rewritten if it were the case.


For Spain, the right adjustment policy would be a programme to force the private sector to deleverage, over three to five years, supported by consistently robust public sector deficits, and yes, accompanied by economic reforms as well. The moment to address the public sector deficit is after the private sector deleveraging is complete. Such a policy would not only smooth the adjustment. It would accelerate it.


But a combination of ultra-lax monetary policies and fiscal retrenchment will delay the unavoidable adjustment. Spain remains stuck in a worsening debt trap, out of which default will be the only escape. If it pursued the agreed policies, it would end up where Greece, Portugal and Ireland are – under a rescue umbrella. This is the most likely scenario for Spain.


In November, I said European leaders had only 10 days to save the euro. My diagnosis then and now is that they have flunked it. The ECB’s policies have not bought time. They have slowed down the political processes and the economic adjustment needed to resolve the crisis. The worst, I fear, still lies ahead.

Copyright The Financial Times Limited 2012.

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Barron's Cover
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SATURDAY, MARCH 17, 2012
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Ready to Rebound
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By JONATHAN R. LAING

After falling 34% over the past six years, U.S. home prices will soon bottom. They could turn back up by spring 2013.


   Matt Collins for Barron's  

  Everyone has shared the pain. The negative wealth effect from the home-price decline contributed to the virulence of the Great Recession.

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It hit with the ferocity of an Old Testament plague, wiping out large populations of homeowners in the U.S. Five million of the country's 76 million mortgage holders have lost their homes to foreclosure or lender-ordered short sales since 2006, and an estimated 14 million more owe more on their homes than their properties are currently worth. In all, some $7.4 trillion in homeowners' equity has been destroyed, according to Mark Zandi, chief economist at Moody's Analytics, and more than two million jobs in the home-building industry disappeared.




At year end 2011, the S&P/Case-Shiller National U.S. Home Price Index fell to a record low, 33.8% below the boom peak level, recorded in 2006's second quarter. The descent has been all the more hideous in such once-manic markets as Las Vegas, Phoenix and Miami, which, according to the Case-Shiller 20-City Composite Index, have fallen 61%, 55% and 51%, respectively, from their high-water marks.



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Everyone has shared the pain. The negative wealth effect from the price decline both contributed to the virulence of the Great Recession and crimped the subsequent recovery.


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Yet as grim as these year-end readings appear to be, there are signs that the long nightmare for American homeowners is in its terminal stage, and that, maybe, just maybe, home prices will bottom and begin to turn by the spring of 2013—if not before.

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Certainly, the economy is doing better these days—the sine qua non for improved demand for housing. Jobs numbers have been up sharply three months in a row, leading to a jump in consumer confidence of late.


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The near-record low in mortgage rates and concomitant slide in home prices has made houses and condos stunningly affordable (although stiff underwriting standards have made getting home loans more difficult). This is captured in the National Association of Realtors Housing Affordability Index, which measures how much purchasing power a median-income family needs in order to buy a median-priced home, using conventional mortgage financing.


.This measure stood at 206 in January, which meant that the typical family has more than double the income needed to purchase an average home. That reading is more than twice the 102.7 at the peak of the bubble in July 2006.



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MUCH OF THE HOME-PRICE DECLINE in the past six years has been fueled by the distress sales of foreclosed properties, which typically sell at discounts of 30% or more to dwellings in the conventional sales market. Distressed sales, along with vacant houses and condos awaiting a sale, trash property values for all the other homes in the immediate area.




These forced sales have weighed heavily on overall market prices that are typically reported on a metropolitan-area basis that includes cities, surrounding communities and exurbs, which are a good distance from downtown. Within many metropolitan statistical areas, a bifurcated market has developed in which a pricing recovery already is under way in communities and neighborhoods far from the areas still reeling from past excesses of subprime mortgages and predatory lending.




This phenomenon is showing up in the statistical service CoreLogic's Home Price Index, which nicely separates distressed from nondistressed sales. Indeed, for all of 2011, prices fell 4.7% nationally from the previous year's level. Excluding distressed sales, however, home prices dropped just 0.9%.
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Of greater moment, perhaps, CoreLogic data show that nondistressed-sales prices rose 0.2% month over month in December 2011 and 0.7% in January 2012. Could this be an augur of better times to come?




Absolutely, in the opinion of Karl Case, professor emeritus at Wellesley College and one of the progenitors of the Case-Shiller indexes, launched in 2002. "If you drill down in the numbers by zip code in the Boston area, as I have done, you find that more desirable, affluent neighborhoods like Back Bay and Beacon Hill are doing just fine now—while, say, Fall River is still in the dumps and dragging down the entire Boston Metro area," he asserts.




This bifurcated market is seen all across the country. While the Nob Hill neighborhood in San Francisco never saw values drop drastically and is now recovering nicely, Stockton, Calif., remains in the dumps. It's a tale of two cities elsewhere, too. The Santa Monica real-estate market is doing fine, while the desert towns to the east are still suffering. And, in the Miami environs, South Beach is strengthening; Hialeah, Fla., isn't.


.Then there are areas that have been so depressed that the only direction now seems to be up.
In fact, woebegone Detroit was the only place in the latest Case-Shiller National Index to show an annual increase for December.


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True, the price increase was a skimpy 0.5%, but that was lots better than the 12.8% slide notched by the Atlanta area for 2011. And the only two metro areas that showed month-over-month gains in December were Miami, up 0.2%, and Phoenix, up 0.8%.



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TO BE SURE, PLENTY OF headwinds remain for home sales. Unlike the stock market, home prices display much long-term momentum and inertia. Prices, all other factors being equal, tend to move in their past direction, and lenders, chastened by recent experience, remain tight with mortgage credit.


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Going through the home-loan application process these days is like undergoing a financial colonoscopy. In contrast, during the salad years of the housing boom, banks were shoving money at borrowers, with few questions asked.


.The biggest impediment to a turn in the home market remains the so-called shadow inventory of some 3.671 million homes, according to estimates by Mark Zandi of Moody's Analytics: those that remain somewhere in the foreclosure pipeline. Payments on some are 90-plus days delinquent; others are already lender-owned properties, known as REOs (real estate owned), that haven't yet been listed for sale.


.This inventory sits atop a market for existing-home sales that this January reached an annual pace of 4.5 million units. Moody's Zandi, for one, finds particularly worrisome the recent $26 billion settlement of charges, alleging malpractice in home foreclosures, reached by 49 state attorneys general and the five largest lenders and mortgage servicers in the U.S. If nothing else, as a result of this, the shadow inventory will hit the home market far faster than it would have otherwise.



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"While I feel better about U.S. home prices than I have in six years, I do think that a pickup in foreclosure and short sales could push U.S. home prices down another 5% this year, before the market bottoms next spring," says Zandi. (In a short sale, the lender and homeowner agree to sell the home at a loss with the proceeds going to the lender in lieu of an actual foreclosure.)

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Others are more sanguine.
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Eleven forecasters surveyed this year by the Federal Reserve Bank of Philadelphia predicted, on average, that the Case-Shiller National Index would fall by just 0.2% this year—and that it would rise 1.2% in 2013. Even if the decline were to reach Zandi's 5% level in 2012, it would be off such a low price base as to be almost imperceptible.


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If the market bottoms out early next year, as Barron's expects, any recovery is liable to be somewhat tepid for a while. Buyer psychology has been shredded by the housing bust: The notion of housing as investment, rather than shelter and a wasting capital good, has been destroyed. Meanwhile, lots of sellers, anxious to downsize or liquidate, remain in the wings, ready to pile into the market at the first sign of a rebound.


.A pricing model recently developed by Goldman Sachs predicts a rise in nominal prices of a cumulative 30% over the next 10 years, for a real return of 1% annually, after adjusting for inflation. But if tax changes like the elimination of deductibility of mortgage interest materialize, long-term appreciation in home prices could hew more closely to inflation, with little in the way of real returns.


.NONETHELESS, THE POSITIVES these days outweigh the negatives.


.Take the daunting 3.7 million homes that Moody's estimates is in the shadow inventory. Zandi points out that this foreclosure pipeline has been steadily shrinking since its peak of 4.53 million homes in the first quarter of 2010. The decline is primarily a result of a precipitous drop in loans entering the foreclosure channel.



The 30- and 60-day early-stage delinquency rate has been dropping like a stone for several years because of tightened mortgage-underwriting standards.


.Likewise, Zandi expects that the shadow inventory could be reduced by at least 700,000, thanks to recent changes in Uncle Sam's Home Affordable Modification Program to encourage lenders to reduce the principal on loans in early-stage default.


.He also expects investment demand from all-cash buyers for homes in hard-hit areas like Nevada, Arizona, California and Florida to take lots of properties out of the shadow inventory. Rising rent rates make the strategy appealing to buyers seeking attractive cash returns while they await a turn in the market.
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The Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, is also encouraging them to make bulk sales to investors of their large portfolios of foreclosed properties.


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CoreLogic's chief economist, Mark Fleming, thinks that the size of the true shadow inventory—the number of homes that will reach the market as distressed salestotals only about 1.6 million. Such transactions, which accounted for 28% of all existing home sales in December, won't return to the record 33% they hit in February 2011, he adds.


.The demand for housing could pick up markedly in the years ahead, just from population growth, or, in census lingo, household formation.


.The Great Recession of 2008-09 sparked a collapse in household formation, as adult children postponed striking out on their own or moved back to their parents' homes after losing, or failing to find, jobs.


.The household-formation rate plummeted to 300,000 during 2008, from more than 1.7 million in 2005. But the Canadian economic research outfit BCA sees the U.S. rate surging to its historic annual average of around 1.3 million in the years ahead, boosting the demand for rental apartments first and then spilling into the housing market. BCA reckons that five million new households will have to be formed simply to return the ratio of households to population to normal levels.


.Perhaps no one knows more about residential real-estate price trends then Yale economist Robert Shiller, the co-creator of the Case-Shiller indexes. He has studied prices going back many years, including those in one neighborhood in Amsterdam that has been around for literally centuries.


.While he's reluctant to predict definitively when the U.S. housing bust will end, he points to one leading confidence indicator that appears to be signaling a market turn—the National Association of Home Builders/Wells Fargo Housing Market Index.



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This monthly survey seeks to capture shifts in builders' perceptions of current and future market conditions and buyer traffic. The index has been on a tear of late, rising five months in a row and to its highest level since 2007. Home-builder stocks likewise have blasted off since the October 2011 stock-market low, with Beazer Homes (ticker: BZH) up some 167%, Toll Brothers (TOL), 81%, and the SPDR S&P Homebuilders exchange-traded fund (XHB) up 74%.




This confidence index, Shiller notes, topped out almost seven years ago, in the very month that he boldly predicted in a Barron's article that the U.S. home market was on the verge of a monumental collapse that would see prices fall an inflation-adjusted 50% ("The Bubble's New Home," June 20, 2005).


."It's amazing how on target that prediction was, since nationally the market is already down 40% in real terms," Shiller said in a recent telephone interview.


.The Yale economist isn't sure why the builder-confidence reading has been such a good leading indicator. After all, the market for new homes even in strong years never accounts for more than 20% or so of all sales; existing houses and condos account for much more. And lately, the figure has sunk to around 6%. Perhaps home builders have a deeper insight into potential buyers' psychology—although if their grasp of market conditions were that good, many of them wouldn't have gone belly-up during the bust.


.The Obama administration certainly hopes that housing is on the verge of a turn. So do the host of homeowners anxious to unload their properties. One very positive sign: The inventory of new and used homes is around a six-month supply, a decline from the peak in 2008 of more than 10 months.


.That bodes well for continued economic recovery and could win President Barack Obama another four years in the White House. But for baby boomers who once hoped to retire on the proceeds of selling a home, the best advice may be: Don't quit your day job.
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Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

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Bank Stress Tests and the All-Clear-to-Rally Signal

March 16, 2012

By Shah Gilani, Capital Waves Strategist, Money Morning



Earlier this week I repeated that I've been cautiously bullish (too cautious, I also said) since October.


I also told you I was optimistic that all the major indexes would break through the important psychological, headline, and large-round-number resistance levels they started flirting with two weeks ago.
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Boy, was that an understatement.

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On Tuesday, markets blew the lid off of any impediments in their way.

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In fact, the price action was so fast and furious you'd have thought the Federal Reserve said something about keeping interest rates low, or maybe that some good news about bank stress tests had leaked out.
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And to think, only one week earlier, markets had a steep fall from grace on account of Fed Chairman Ben Bernanke not saying anything about another round of quantitative easing.
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What a difference a week makes.
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In case you missed the psychology of the market, it went like this...


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The Little Mind-Game Twist That Scared the Shorts

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On Tuesday the week before, the markets fell because Bernanke was more optimistic on the U.S. economy than he has been. So markets thought the liquidity party might be coming to an end.
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Then this Tuesday, the FOMC minutes reiterated the Fed's pledge to keep fed funds between 0% and ¼% through 2014.
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After the markets initially digested the FOMC minutes as being negative - because again there was no mention of further easing - they made the most of the news and decided that a statement confirming rates would be kept low until the end of 2014 was a lot better than no mention of the extended timeframe.
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That little mind-game twist scared a lot of shorts.
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As the major indexes were flirting with resistance levels, and failing to convincingly break out, traders were becoming more negative and more short positions were being put on.
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Also, investors, sitting on great profits since the huge run-up from October, began to put on hedges and even sold into last Tuesday's blow off.
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But with the Fed saying they were staying the interest rate course they'd set through 2014, short-sellers decided there was too much upward momentum to fight. They began to cover.



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And then some tidbits about the bank "stress tests" started to leak out...

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Bank Stress Tests: A Beauty Contest for the Public's Benefit


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Seems the markets remember the rally in 2009, the last time we got news that, although some banks needed to add capital, the whole system was in better shape than the public had come to fear.
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It's all about timing.
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A little short-covering, a breakthrough above resistance levels, and a good pinch of reality that banks aren't under stress at all. It all makes for an explosive rally.
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But seriously, did anyone think that we were going to find out that the banking system was about to go down the drain? Of course not.
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Who conducted the stress tests?
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Why, that would be the Federal Reserve, who just happens to already know everything they need to know about the 19 big banks they were "testing!"
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It wasn't a test. It was a beauty contest put on for the public's benefit. The Fed wanted to show how beautiful America's banks were, and would be, in the face of some horrible disaster.



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The whole exercise was like an episode of "American Idol," or some awards show.
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Here's what it looked like to me.
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The never-say-too-big-to-fail, naughty-nineteen bank contestants, all of whom made it through the first round of stress-test auditions in 2009, were anxiously awaiting the judges' scores to determine who would be the 2012 American Banking Idol..
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The winner would be picked by the pageant's executive producer (the Sisterhood of Bankers for Bankers, otherwise known as the Fed), who used its own internal accounting peeps (allegedly run by Madoff's former accountant from his community service workshop) to tally the votes..
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The rules this year required all contestants to spend untold hours (though most have tallied them and will complain bitterly) and untold sums of money (which they can write off, like they do with all those pesky settlements) to determine how they would fare if:

  • the stock market fell 50%,
  • U.S. GDP shrank 8%, and

  • unemployment was 13% (as measured by the simple birth/death ray total participation dissecting model, divided by seasonal adjustments and political mandates, times the square root of U6), in other words, not too far from where it actually is now.
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But that's not all. Some of the more international contestants would have to make assumptions about Germany directing the European Union to march under its boots and what might happen if Euro-zone members flying the euro currency rag don't all say "Achtung Baby."

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The figures the judges were watching, as the contestants paraded in their skivvies, included leverage ratios and Tier 1 capital that the banks would openly display under the dire scenario, starting now and staggering quarterly through the end of 2014.

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While it should be noted that the judges' votes are final, the banks themselves will conduct a separate, self-directed, look-in-the-mirror evaluation of their figures and flaws, as required under Section 165 of the most exact and concise law ever not written - the Dodd-Frank Act.
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I bring this up because some beauty contestants may balk at how a group of presumptuous outsiders sees them, as opposed to how they actually see themselves.
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However, I'd like to point out that no one's calculations really matter anyway, on account of the fact that there is no common mathematical thread woven through anyone's internal modeling of risk weightings, duration exposure analysis, counterparty risk, or operational and reputational risk metrics.


So the judges will judge, don't worry about it, because they're all too big to fail, anyway.

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Now imagine the anticipation, waiting for the Fed's determination about America's banking idols.


The envelope please.


"And the winner is..."

"Ladies and gentlemen, this is amazing... We have a tie... The winners are... all of the banks!"
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Accepting the award on behalf of all the banks will be the on voted "Most Congenial to Regulators," Wells Fargo, and the bank voted "Most Dismissive of Its Critics," the lovely JPMorgan Chase.
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In case you didn't stay up late enough on Tuesday night, here's a copy of their acceptance speech.

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"This is unbelievable! First, we'd like to thank the Federal Reserve for painting such a dire future that they knew none of us could survive, so they had to accept our submissions without asking any of us who made them up. And we'd like to thank all the regulators for covering up for us these past four years when most of us, okay all of us, were insolvent and they all lied for us. Thank you. And, last but not least, we'd like to thank the public for believing in these meaningful contests, for listening to each of our CEOs and our regulators when we tell you that we're all healthy and you go ahead and buy our equity and wholeheartedly embrace our subordinated debt, which you know is government backed. Thank you all. We'll see you next year."

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So much for stress tests.