Charlie Munger will surely agree with John Kay

July 28, 2010 at 2:35 pm Leave a comment

John Kay wrote in FT about how absurd the stress test done on European banks was. He said that stress test should be held up to engineering standards.

“The concept of stress tests is derived from the procedures used to ensure the robustness of complex engineering structures. There are three stages. You begin by testing each component in conditions considerably more demanding than it is likely to encounter. Then, you review system design to ensure that, even if several elements break down simultaneously, this does not jeopardise the integrity of the whole structure. Third, and most importantly, you test the total system for outcomes far outside the range of experience. You do not ask, “Will the bridge survive a strong gust of wind?” You ask, “Will it survive a gale worse than any at this site in the last century?”

Obviously, the stress test was a farce which Charlie munger who told a story of Roman builder standing underneath a bridge he built and allowed heavy loads to pass thro bridge (that is really a stressful test,both for the bridge and the builder) will throw potshots.

John Kay concluding paragraph says it well:”Shamefully, the purpose of the stress tests is not to ensure that depositors’ money is safe or that taxpayers will not be called on again. The purpose is to reassure banks and their shareholders that they will not be required to provide significant additional capital. The lesson – perhaps the only lesson – of the stress tests is that Europe’s politicians and regulators have not begun to address, far less resolve, the issues posed by the crisis of 2008.”

Entry filed under: Watch your step. Tags: .

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