Many years ago the old prof was an aspiring prof, traveling back from a bridge tournament with the team.  There was an appealing place to stop — a truck stop, in fact — so we entered and sat down at a table.  A waitress (and in those days that was the politically correct term) came over instantly and took our order.

A minute later another person entered, looked around, and sat down at our table!  We were very surprised, but unsure about what to say.  The new party to our table starting talking  immediately — smokey’s, crazy drivers, how the wind was whipping the rig around, etc.  He was using terms unfamiliar to us.

At this point one of us noticed the sign over our table:  Truckers Only!  It was a table for truckers to meet and talk.  We were out of place.  Our conversation would have been instantly identified by a real trucker as that of a regular motorist.

Meanwhile, the trucker could not have discussed limit raises or double squeezes, but it was not a table for bridge players.

There is a simple point.  Experts can identify experts and also impostors.

The Stress Test

With this illustration in mind, let us consider Monday’s highly-publicized “leak” of the stress test results.

While the source did not provide exact quotes, it is obvious to anyone familiar with government documents that this is not a real report.

• The breathless tone.
• The inclusion of a non-US bank.
• The emphasis on current insolvency.
• The inclusion of other topics, like overall debt.

The stress tests involve a number of different scenarios, examining how a given bank portfolio might do under difficult circumstances, mostly drawn from economic projections.  It is not expected to reveal “insolvency” but to identify problems and lead to solutions.  Banks that might need additional capital will be identified.  The government will work with them to explore various options.  It is not intended as an overall verdict on the banking system.

The examination is bank-by-bank, with the emphasis on dealing with potential problems.

Briefly put, the summary of the report does not “ring true” for anyone with experience in reading government documents.

What Happened?

The most likely explanation is that someone provided a fake document, for motives that can only be guessed.

The amazing result is that so many are willing to accept such information at face value, in the face of explicit denials from the Treasury Department.  It shows the willingness of traders and bloggers to believe in leaks and conspiracies.

The original source now has “corrections and additions” which correct some of the original problems.  The most important of these is the assertion that there is already official acknowledgment that the results are known.  Let us examine this “evidence.”

This is pretty easy to answer.  The Fed made it clear — in anticipation of specific results — that they did not want banks claiming that they had “passed the test.”  It would call into question any institution that did not make such a claim.

Think about it.  There is nothing in the statement from the Fed that suggests that results were already known.  It was made before the tests were completed.  In no way does it suggest that there is “a lie” about reports.

Investment Conclusion
From the always reliable Abnormal Returns we know that this was still an issue today.  So many want to believe in the failure of the banking system.

Several pundits have argued that if the stress test shows that banks are OK, they will not believe the results.  If it shows problems, it will be time to sell the financial stocks.

Briefly put, many traders and investors are not very interested in the evidence.  In the long term, this is a contrarian opportunity.  Meanwhile, we should expect plenty of skepticism when there is an official report on May 4th.

Last 5 posts by Jeffrey Miller

• A Tough Nut to Crack - October 29th, 2009
• ETF Update: Looking to the Internet - October 25th, 2009
• Healthcare Reform Becoming Less Likely - October 21st, 2009
• ETF Update: Another Look at the Banks - October 18th, 2009
• Identifying Quackery (and Other Mistakes) - October 6th, 2009