Do you hear that ticking sound?
Today it was leaked that the Federal Reserve has requested a "contingency plan" for Bank of America (BAC). Supposedly, this includes the possibility of spinning off Merrill Lynch for some extra cash.
Such a request for a plan is extraordinary. It proves that the Fed’s so-called "stress tests" are flawed. What is the difference between "if business conditions worsen" and the "adverse scenario" of the stress test?
I will argue that the flawed stress tests have given the public, regulators and the banks a false sense of security. As a result, the banking system is unprepared for a realistic adverse scenario.