Geithner’s Worst Case Scenario is Now Here

The widely discussed stress tests were published yesterday evening and showed that capital shortfalls of some of the largest banks were significant. Bank of America (NYSE: BAC), Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), and 7 others were being asked to raise roughly $75 billion in order to shore up their balance sheets.

This “test” was meant to see how the top 19 banks would hold up in a worsening economy; using both an opitimistic and pessimistic set of assumptions. I want to focus primarily on the pessimistic assumptions for now; specifically the assumption that the unemployment rate for 2009 would be at 8.9%. Well, Mr. Geithner, just this morning there were 539,000 layoffs in April, which brought the total unemployment rate for 2009 (thus far) to 8.9%.

Uh-oh.

We are now facing the most stressful situation the stress test assumed 7 months before the end of 2009, with layoffs occurring at blistering speed each month (though they have slowed). It’s my estimation that an unemployment rate of 10% is far more likely in 2009, which represents a 12% increase over the worst case assumptions of the stress test.

Now I’m not entirely sure what this would do to the capital requirements for the largest banks, but I am sure that it’s worse than we are being told. Obviously I don’t mean to insinuate we’re being lied to, rather the set of assumptions were overly optimistic. I am making sure my clients are well protected against the real worst case scenario and highly suggest you do the same.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.