The Federal Reserve released its monthly minutes yesterday, and for the first time in recent memory, some parts of the outlook were fairly chipper. "Financial market conditions," it states, have "generally strengthened, and surveys and anecdotal reports pointed to a pickup in household and business confidence." One piece of data that caught my attention was the Fed's unemployment expectations. In an upward revision from its last meeting, the Fed now expects the jobless rate to be between 9.2% and 9.6% by late this year. These are interesting numbers when compared with the Treasury's recently completed stress test. That test which was used to determine whether banks were adequately capitalized under a worst-case scenario assumed that 2009 unemployment would fall between 8.4% in a baseline scenario and 8.9% in the worst-case scenario. In other words, the Fed's baseline outlook is grimmer than the Treasury's worst-case outlook. These funny inconsistencies remind us why economics is an art, not a science. Why fret over a handful of basis points, you say? Simple: According to some Fitch Ratings analysis, there's a historical one-to-one correlation between unemployment and prime credit card charge-offs. That is, if the unemployment rate doubles, so does the credit card charge-off rate. It's even worse for lower-quality cards. When you're talking about numbers this big, an increase in the charge-off rate of a few dozen basis points is nothing to sneeze at. One piece of data that caught my attention was the Fed's unemployment expectations. And since the stress test's goal was to adequately capitalize banks, the thought that more money may need to be raised in the future doesn't seem far-fetched. Investors are infatuated with this stock. They seem to ignore the considerable uncertainty and risk that lie ahead. Now up more than 30% year to date, Visa's shares are priced for perfection and nothing else. Visa's not invulnerable to the dwindling economy. In fact, it's extremely vulnerable to consumers' strength or weakness. Before you send that hate mail, let me explain. This is pretty serious stuff. On average, it's an expectation of 17.4% annual growth, based upon predictions that Visa along with rival MasterCard (NYSE: MA) will ride a global shift from paper to plastic commerce. These assumptions are also based on a business model that accepts no credit risk. Unlike American Express (NYSE: AXP) or Discover (NYSE: DFS), Visa simply makes money off transactions an inherently safe and lucrative business model. It's great work if you can get it. And investors know this. They're so confident, in fact, that shares have been bid up to more than 24 times this year's earnings, and more than 20 times next year's. Will it be the end of the world for banks? For most, no. That test which was used to determine whether banks were adequately capitalized under a worst-case scenario assumed that 2009 unemployment would fall between 8.4% in a baseline scenario and 8.9% in the worst-case scenario. But when the Federal Reserve's own projections challenge the Treasury's stress test by what could equal billions of dollars of losses for several banks, there's yet more reason to wonder whether the test was more of a confidence campaign than an objective and realistic analysis.
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