What are Bank Stress Tests? - Bargaineering

Posted: 29 Nov 2010 09:35 AM PST

During the financial crisis, government officials often talked about performing “stress tests” on the financial institutions to see how they would fare if the financial crisis worsened. I didn’t really understand what they meant by “stress tests” because I didn’t see how you could do traditional stress testing, as you would on like a chair, on a bank. If you’ve ever been to an IKEA, you’ve probably seen them demonstrate durability with stress tests (the classic robotic pushing down on the POÄNG Chair and the labeled floorboards that talk about the number of people who have walked over them), but how do you stress test a bank?

In reality, a bank stress test is simply scenario analysis. What would happen if the stock market, say the S&P500 index or the Dow Jones Industrial Index, fell by 20%? 50%? What happens if the yield on the 30 year Treasury increases or if the Fed increases the federal funds rate? Analysts run these various scenarios and look to see how the bank will perform (i.e. survive) under these extreme conditions.

In learning that’s what stress tests were, I was surprised these weren’t part of the usual risk analysis process. I’ve always understood risk analysis to be a look at the probability and severity of a event happening, it appears that banks, perhaps in their zeal, ignored anything with a low probability even if it might sink the firm. As an investor, I’d like to know what the various risks to a company should things go north or south.

Then again, when your bonus is tied to annual performance, big wins in 2010 followed by catastrophic losses in 2011 still means a huge 2010 bonus.

What are Bank Stress Tests? from personal finance blog Bargaineering.com.

Should You Walk Away from Your Mortgage?

Posted: 29 Nov 2010 04:18 AM PST

A lot of people are “underwater” on their mortgages, that is the value of their home is below the amount they still owe on their mortgage. Other people simply can no longer afford their monthly mortgage payments and are on the verge of being foreclosed on. Regardless of the reasons, some homeowners are considering walking away from their home and their mortgage and it’s important to understand what the actual costs are going to be.

Why You Should Walk

1. It’s simple math. If your home is worth $100,000 and you owe $120,000 on your mortgage, you’re $20,000 in the red. You can continue to pay the mortgage, which includes interest and taxes that you’ll never recover, and pay $1.20 for something you know is worth $1.00; or you can walk away and save yourself a ton of money. The simple math screams that you should walk away because you don’t want to pay more money for the right to lose money.

2. It’ll save your finances. If you’re one of the many homeowners who simply cannot make the payments or are dangerously close to not being able to make the payments (and meet other obligations), save yourself the knife juggling act and take the biggest knife out of the rotation. By removing that obligation, perhaps it puts you in a better position to meet other obligations.

3. You don’t owe the bank anything. It’s a business transaction. They gave you an interest rate that was designed to protect them in the event you defaulted. You have no moral obligation to keep paying them just because you agreed to it. You can terminate the contract, return the house, and face the financial consequences afterwards. The house has become a parasite on your financial life, you don’t owe the parasite a free ride.

Why You Should Stay

1. You can still live there. With a home, you can always live there and there’s value in that. You might be underwater but if it’s not too bad, it might make sense for you to stick around and let home prices recover. Be sure to contest your property taxes so you give yourself some breathing room.

2. Walking will destroy your credit (for a few years). When you walk away, the loan will default and that will be reflected on your credit report. It’ll become harder for you to get a loan for several years and you should be prepared to be treated a little differently. Your credit score will suffer but after a few years the effects should diminish.

Ultimately the decision comes down to your personal beliefs and your specific financial situation, I just hope this article gave you a brief idea at the considerations on both sides. You have the make the decision based on how it helps you and your family, that’s who you’re responsible for, and not to base it on what others think or feel.

(Photo: mcgraths)

Should You Walk Away from Your Mortgage? from personal finance blog Bargaineering.com.