Meet Sir Allen Stanford. Sir Allen is a Texas billionaire and a knighted citizen of Antigua.

Sir Allen has been charged with running an $8 billion fraud.

Current whereabouts unknown.

Cake decoration by Ryan Hettena, age 3.

On Feb. 10, shortly after Timothy Geithner announced that the government would perform “stress tests” of major American banks, the U.S. treasury secretary was asked what amounts to a trillion-dollar question. Well, at least at half-a-trillion.

“Do you think that are largest banks are insolvent?” Sen. Jim Bunning, R-Ky. asked Geithner later that day. “What will you do if your stress test of major banks reveal that they are insolvent?”

The New York Times’ Dealbook blog published the results of an two-year, independent bank stress test:

CreditSights ran the numbers, and found that according to its “severe” case situation, all the major banks and brokerages — Citigroup, Bank of America, Wells Fargo, JPMorgan Chase, Goldman Sachs and Morgan Stanley — might require further capital injections from the government….

The future losses for some banks are staggering by CreditSights’ estimates: Wells Fargo, $119 billion; BofA, $99 billion; JPMorgan, $124 billion; Citi, $101 billion; Goldman Sachs: $47 billion; Morgan Stanley, $34 billion.

To put these numbers in context, consider the market capitalization of these companies: Wells Fargo, $67 billion; BofA, $36 billion; JPMorgan, $92 billion; Citi, $19 billion; Goldman Sachs $44 billion; Morgan Stanley $25 billion.

In other words, the owners of the banks (shareholders) have not invested enough capital to cover the potential losses in assets in most cases.

Guess what that means! If the worst comes to pass, America’s biggest banks are effectively nationalized! Only the government can cover losses of that magnitude.

The sooner we wake up to this fact, the sooner we can move forward.

Andrew G Haldane, Executive Director for Financial Stability, Bank of England: 

Back in August 2007, the Chief Financial Officer of Goldman Sachs, David Viniar, commented to the Financial Times: “We are seeing things that were 25-standard deviation moves, several days in a row.”

To provide some context, assuming a normal distribution, a 7.26-sigma daily loss would be expected to occur once every 13.7 billion or so years.  That is roughly the estimated age of the universe.   A 25-sigma event would be expected to occur once every 6 x 10124 lives of the universe. That is quite a lot of human histories.

When I tried to calculate the probability of a 25-sigma event occurring on several successive days, the lights visibly dimmed over London and, in a scene reminiscent of that Little Britain sketch, the computer said “No.”

Fortunately, there is a simpler explanation – the model was wrong.