FSA planning for worst recession in 60 years

The FSA's worst-case scenario has unemployment at 12%, house prices down 50%, and GDP down 6%...

Last Updated: 31 Aug 2010

The FSA has surprisingly released details of the methodology it uses to ‘stress-test’ our banks and building societies, and some of its assumptions are a bit alarming. Even now, it’s expecting a 6% drop in UK GDP, with no recovery until 2011 – which would be the worst decline since the Second World War. It’s also planning for the unemployment rate rising to 12%, up from its current level of 7%, and for house prices falling 50%, about twice as much as they have done so far. Unlike the US, the FSA claims it’s now doing these tests on an ongoing basis. Pity it didn’t think of that five years ago.

The FSA uses the stress-tests to make sure financial firms have a sufficiently large capital buffer, i.e. enough cash in the bank to cover 4% of their assets. But until now nobody knew exactly what the tests involved – and after the US decided to publish the results of its own process, calls for greater transparency on this side of the pond have been growing (led by – you guessed it – omnipresent Lib Dem MP and recessionary sage Vince Cable). However, today’s revelations came as a bit of a surprise; only last week, the Treasury blocked a freedom of information request on this very subject from Bloomberg, on the grounds that it might frighten investors.

Judging by today’s statement, we can see why. Its current model assumes this recession will be ‘more severe and more prolonged’ than those of the 1980s and 1990s – the worst for 60 years, in fact, with UK output falling 6% peak-to-trough and no return to growth until 2011. It also checks how the banks would cope if unemployment were to rise to 12% (that’s 3.7m people out of work), and, even more importantly, if commercial and residential property prices were to slip 60% and 50% respectively (since this would hammer their asset values). All of these are worse than current forecasts – house prices, for instance, are predicted to drop about 33%.

However, today’s news doesn’t seem to have spooked the markets too much (the FTSE is down slightly, but largely for other reasons). For one thing, this is just a worst-case scenario – it may never come to pass. And for another, it reassured investors who were worried the assumptions would be even worse – the big advantage of greater transparency.

Still, the FSA will only be going so far down the US route; it won’t be naming and shaming individual institutions, apparently because its regime is being ‘embedded in our regular supervisory processes’ as opposed to being a ‘one-off exercise’. Unfortunately, the FSA also admitted that it has only started doing this relatively recently – which smacks a bit of shutting the gate after the horse has bolted...

In today's bulletin:

FSA planning for worst recession in 60 years
Psst, wanna buy a car maker? Vauxhall jobs in balance as GM talks stall
Nestle encourages staff to take a long walk
Editor's blog: Recession puts wind in bean sales
Nick Hood: Wall Street worries about crypto-Communism

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