Backed into a Corner
The governments of Germany, France and Spain have officially made the commitment to open the financial kimono towards the end of June/early July and reveal banking stress test results. Based on the stated objections of the head of Germany's landesbanken, I'd say there will be some ugly results. But this is an absolute necessity to move forward.
Ever since the Minsky Moment, the eurobanks have played the carry game, borrowing for free from the ECB and buying sovereign debt. Their capital requirements are low for this type of asset but still allow some yield with PIIGS sovereign debt. So while the US and the UK forced their banks to clean up and recaptialize with proper funds (we think), the ECB simply allowed banks to lower asset risk, lowering capital requirements and allowing them to avoid a costly recapitalization.
Unfortunately, the banks now own a ton of PIIGS sovereign debt, so what was until now a concern about the sovereign solvency of the PIIGS has moved to a concern about the solvency of the core euro country banks, and by association, the core euro sovereign solvency. It seems a fair bet that Germany is facing the double whammy of low grade PIIGS sovereign and impaired commercial assets. Spain has the impaired commercial assets plus Portugal and France maybe only the PIIGS sovereign exposure.
Collectively, the sovereign balance sheets backing the Euro are about to get a lot worse in the mark to market event that is the stress test. The good news is that should be the end of the bank solvency uncertainty and allow investors to operate with better information. The bad news is that the results will likely put more pressure on the core countries to cut budgets, kill near term GDP growth and set the western world up for a very tough 2H'10 and '11.
That suggests monetary tools will be more important and low rates for longer and more deflation. It seems that in order to avoid an insolvency debt trap, the budget cuts will be big and economic growth ugly for a while. I don't know if that's the right decision, but it is the one that governments appear to be making. I am starting to wonder if one of the results of the stress test reveal will be a big hit to gold; after all, we will finally have known financial balance sheets. Gold is for the unknown.
Still liking the rally, looking for a bigger right shoulder. Have been hugely oversold and expect more bounce. Micron numbers coming in a couple weeks, should kick off a strong tech rally into the quarter. Own oil - the GoM crisis is hideous, but doesnt it make oil more expensive? The counter argument and I think longer term one is that the above notes on crap GDP growth mean oil goes lower. Long the GBP, ISSI, AAPL, BAC, AMAT. Starting to look at long dated S&P Taleb puts...
The governments of Germany, France and Spain have officially made the commitment to open the financial kimono towards the end of June/early July and reveal banking stress test results. Based on the stated objections of the head of Germany's landesbanken, I'd say there will be some ugly results. But this is an absolute necessity to move forward.
Ever since the Minsky Moment, the eurobanks have played the carry game, borrowing for free from the ECB and buying sovereign debt. Their capital requirements are low for this type of asset but still allow some yield with PIIGS sovereign debt. So while the US and the UK forced their banks to clean up and recaptialize with proper funds (we think), the ECB simply allowed banks to lower asset risk, lowering capital requirements and allowing them to avoid a costly recapitalization.
Unfortunately, the banks now own a ton of PIIGS sovereign debt, so what was until now a concern about the sovereign solvency of the PIIGS has moved to a concern about the solvency of the core euro country banks, and by association, the core euro sovereign solvency. It seems a fair bet that Germany is facing the double whammy of low grade PIIGS sovereign and impaired commercial assets. Spain has the impaired commercial assets plus Portugal and France maybe only the PIIGS sovereign exposure.
Collectively, the sovereign balance sheets backing the Euro are about to get a lot worse in the mark to market event that is the stress test. The good news is that should be the end of the bank solvency uncertainty and allow investors to operate with better information. The bad news is that the results will likely put more pressure on the core countries to cut budgets, kill near term GDP growth and set the western world up for a very tough 2H'10 and '11.
That suggests monetary tools will be more important and low rates for longer and more deflation. It seems that in order to avoid an insolvency debt trap, the budget cuts will be big and economic growth ugly for a while. I don't know if that's the right decision, but it is the one that governments appear to be making. I am starting to wonder if one of the results of the stress test reveal will be a big hit to gold; after all, we will finally have known financial balance sheets. Gold is for the unknown.
Still liking the rally, looking for a bigger right shoulder. Have been hugely oversold and expect more bounce. Micron numbers coming in a couple weeks, should kick off a strong tech rally into the quarter. Own oil - the GoM crisis is hideous, but doesnt it make oil more expensive? The counter argument and I think longer term one is that the above notes on crap GDP growth mean oil goes lower. Long the GBP, ISSI, AAPL, BAC, AMAT. Starting to look at long dated S&P Taleb puts...
posted by Lionel at 9:11 AM
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