$550 Billion in Losses, No Bailouts, All Clear: The Banks Just Passed Their Trial by Fire

DFAST Stress, Winners & Losers, and Staggering Numbers from the Fed's Annual Armageddon Test

Every year, the Federal Reserve plays god.

It builds a financial Armageddon from scratch. Not the kind where Bruce Willis hops on a rocket ship with a band of drilling misfits to save the world. The kind where the worst things imaginable happen to the economy, the banking system, and the financial fabric of society. No bailouts, in theory. No liquidity lines. No Hollywood heroics. Just a financial asteroid coming for the US and attempting to create an extinction level event. They call it DFAST. But what it really is, is simluated destruction. A ritual designed to expose which institutions are built for the end of the world, and which are only built for the bull market.

I review these every year for a few reasons. Number one, it is an industry risk clearing event. The sharps know how things will shake out, but the generalists receive comfort as does the broader investing community from this “stamp of approval” on the resilience of the banking system. Number two, it sheds light on who can and cannot give back capital, who is too thin to go on offense. And number three, it gives me a sense of second and third level effects on parallel industries like Private Credit or Credit Card lenders.

The mechanics are simple. Take the 22 largest banks in America and drop the asteroid (without Bruce Willis and Steve Buscemi on it) right onto the banking system in fallout that would make 2008 look like a soft patch. Unemployment explodes from 3.7% to 10%. Real GDP collapses by 7.8% peak-to-trough. Housing prices fall 33%(pure ecstasy for builder stock bears). Commercial real estate prices crater 30%. Equity markets lose 50% of value, wiping trillions off family net worth in almost and an instant. The 3-month Treasury yield plunges from over 5% to zero. Investment-grade credit spreads widen 390 basis points. Liquidity disappears. The bid vanishes. The curve flattens into oblivion. Short rates anchor, long rates dive, and funding pipelines seize in place. Repo markets choke. Securities don’t roll. The system breathes volatility and hemorrhages confidence.

This is truly financial Armageddon … simulated … but still Armageddon.

And while this level of event would certainly reset bank stocks down at least 50% if not 60% or 70%, the analysis shows that fundamentally the US banking system is strong. The analysis also tells me which banks are longs and which ones to avoid, which is very … very valuable information.