THE STRESS EUROPE WON’T TEST

The Wall Street Journal

  • JULY 18, 2011

Regulators don’t want to reveal how vulnerable banks are to a sovereign default.

  • Almost every bank in Europe passed the latest round of stress tests, according to results released Friday night by the European Banking Authority. A lot of good that news did.

Stock prices came under pressure around the world on Monday, the euro hit new recent lows, and gold briefly traded above $1,600 an ounce. Economist Michael Darda wrote that he even detected a “systemic risk flutter” in some interest-rate swap spreads, which is a warning.

The entire point of stress tests is to identify problem banks so they can be closed or recapitalized, and the resulting transparency is supposed to reduce the chances of panic. But since Europe’s regulators still won’t test for the effects of a sovereign default on banks, this year’s results—like last year’s—won’t stop the crisis of confidence in the continent’s financial system.

When Europe’s bank regulators excluded sovereign default from their bank stress tests last year, they could at least argue with a straight face that the possibility of a default by a euro-zone member looked remote. One year later, a default in Greece looks all but inevitable, and others may not be far behind.

The opponents of default and debt restructuring argue that if Greece forces haircuts on its creditors, the resulting bank losses could cascade through Europe’s financial system and produce a panic like the one in 2008. But the likelihood of such a panic depends crucially on how much the banks are exposed to the debt of Greece, Ireland, Portugal and Spain. How can regulators—much less taxpayers or investors—know the risks if the stress tests fail to ask how much exposure there is and how many banks could survive it?

It’s impossible to fix a financial problem if you won’t even dare admit how big it is.

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