By MarketWatch
NEW YORK (MarketWatch) — Thursday’s massive selloff in the U.S. market was initially blamed on lackluster data and the lack of a plan in Europe.
But as morning trading progressed, it became clear that banks had spooked the markets and led the broader indexes lower. The Dow Jones Industrial Average DJIA -3.53% and the Standard & Poor’s 500 index SPX -4.02% were off more than 4% within the market’s first trading hour, while the Philadelphia KBW Bank index BKX -4.88% was down more than 5%. Read report on financial stocks .
This isn’t simply a matter for banks continuing to be the post-financial crisis laggards. U.S. banks may be exposed either directly or indirectly to a sovereign debt crisis in Europe, just as European banks with large U.S. arms are obviously exposed.
It doesn’t matter if a crunch happens in the U.S. or Europe. Banks, we’ve learned the hard way, are interconnected through borrowing and securities agreements. Derivatives keep them close too.
The Federal Reserve Bank of New York, as the Wall Street Journal reports, isn’t letting this precarious state go unnoticed. There have been extensive meetings with top officials at big banks. The main question being asked: in the event of a crisis, will you have enough cash? Read WSJ story on NY Fed’s look at bank exposure .
In asking, the N.Y. Fed is conducting what really amounts to a on-the-fly stress test. Previous stress tests ordered from Washington examined how banks would fare in a second recession, mortgage crisis or a bank run. Europe wasn’t a primary concern.
The good news is that ample capital is the tonic for any crisis that sends depositors and counterparties fleeing. The bad news is that Europe’s version of the stress tests were deemed less rigorous given the region’s multiple regulatory bodies and rules.
Ultimately the best test would be the thing everyone doesn’t want: a crisis. Unfortunately, the markets, at least for today, are betting that brand of stress test is coming.
