Click, Clack, Click: The Sound of Falling Dominoes Behind The Door of the Eurocalypse!

I have decried the virtual collapse of the EU banking system beginning in 2009, and through 2010 and 2011. I have even delivered keynote speeches at EU banks on the very same topic...

The points made in this video are, in my oh so not so humble opinion, incontrovertbe. As a matter of fact the farce, the political fame being played in the hold to maturity accounting arean is enough to spark both a bank run and a resulting banking collapse. I know my proclamations sounded rather bombastic when I first made them. They sounded sensationalist last year. Well, pray tell, how do they sound now?

UK banks abandon eurozone over Greek default fears

UK banks have pulled billions of pounds of funding from the eurozone as fears grow about the impact of a “Lehman-style” event connected to a Greek default.

 Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to eurozone banks, raising the prospect of a new credit crunch for the European banking system.

Standard Chartered is understood to have withdrawn tens of billions of pounds from the eurozone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal.

In its interim management statement, published in April, Barclays reported a wholesale exposure to Spain of £6.4bn, compared with £7.2bn last June, while its exposure to Italy has fallen by more than £100m.

One source said it was “inevitable” that British banks would look to minimise their potential losses in the event the eurozone crisis were to get worse. “Everyone wants to ensure that they are not badly affected by the crisis,” said one bank executive.

Moves by stronger banks to cut back their lending to weaker banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a

seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

 

Eurocalypse Cometh! Principal Haircuts, Serial Bailouts, ECB Insolvent! Disruptive Sound Of Dominoes In Background Going "Click, Clack"! BoomBustBloggers Instructed To Line Up Bearish Positions Again! 

If one were to even come close to marking the EU banks books to reality, market prices, or anything in between, the Lehman situation would look tame in compariosn!

As excerpted from the subscriber document:  The Inevitability of Another Bank Crisis

It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking Crisis

For Those Who Failed To Heed My Warnings On Portugal, Visualize The Contagion That Causes European Bank Failure!!!

Is Another Banking Crisis Inevitable? 

Bloomberg reports that Goldman Sachs Turns Bullish on Europe Banks as Debt Risk Eases.The report goes on to state:

The U.S. bank that makes the most revenue from trading advised investors to take an “overweight” position on banks, raising its previous “neutral” recommendation, according to a group of equity strategists led Peter Oppenheimer. Investors should pay for the trade by lowering holdings of consumer shares, he wrote.

“For financials the narrowing of sovereign spreads in peripheral eurozone, which our economists expect to continue, is a clear positive,” London-based Oppenheimer wrote in the report dated Feb. 3. “Banks are one of the least expensive sectors in the market and the trade-off between their growth prospects and earnings in the next few years looks especially attractive.”

Unfortunately, the risks of this particular trade were not articulated, and I feel that the risks are material. Far be it for me to disagree with the "U.S. bank that makes the most revenue from trading", but they have been wrong before - many times before. Reference Is It Now Common Knowledge That Goldman’s Investment Advice Sucks??? or Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? for more on this topic...

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

 

Euro banks remain weak as compared to their US counterparts

 

Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.

 

EURO Stress Test Rebuffed, Again

 

The OECD working paper “The EU stress test and sovereign debt exposures” by Adrian Blundell-Wignall and Patrick Slovik rebuffs the EU stress test, as we have several times in the past. The argument in the white paper echoes BoomBustBlog view that accounting policies allows banks and financial institutions to mask their true economic health. An asset that has declined in value leads to economic loss irrespective of its classification as held-to-maturity or held-for-trading, but accounting policies allow banks to mark down only their trading portfolio to the current market value while leaving a large chunk of held-to-maturity at book value even if said asset loses 50% in value that would take years to recover, or the bank could be presented with the very distinct possibility that there may be no recovery of said value loss. The former event (of recovering back to book value) would mask the true economic picture at a given snap shot of time while the latter (no recovery) is more of time shifting distortion wherein current profits are inflated for future losses.

 

Coming back to the EU stress test, the paper contends that by focusing only on the trading book exposures, the EU stress test gave a rosy picture of banks true health.

 

•     Sovereign bond haircuts were applied only on the trading book holdings with implicit assumption that bonds held to maturity will receive 100 cents in the euro. This assumption severely understates the banks losses as 83% of banks investment portfolio is in banking books in form of held-to-maturity assets while only 17% of assets are held in trading portfolio. In case of sovereign default, the distinction between the banking book and the trading book simply disappears. By considering only a smaller component of banks investment books, EU stress tests have severely undermined the estimated write-downs on banks books and have given rosy picture about banks true health. The logic of said methodology is that with the EU/ECB/ EFSF SPV (basically, a giant new European CDO) backing, no sovereign state will be allowed to default.

 

•     Second, and more importantly, the market is not prepared to give a zero probability to debt restructurings beyond the period of the stress test and/or the period after which the role of the EFSF SPV comes to an end.

 

o   The assumption of no default over 2010-2012 appears reasonable given that the EFSF is made up of a €720bn lending facility (€220bn from the IMF; €60bn from the EU; and the SPV can build exposures for 3 years to the limit of €440bn for the 16 Euro area countries) which provides a guarantee of funding for any countries facing financing pressures, certainly for the next 3 years.

 

o   However, the concerns in the market beyond 2012 are: the longer-run fiscal sustainability problem; and the difficulty of achieving structural adjustments in labor and pension markets and ability to achieve a sustainable growth in a period of budget restraint. The fear is that this will not be resolved by the time the support packages run out, and hence the probability of restructuring may not be put at zero by portfolio managers. Angela Merkel has recently announced her willingness to spearhead several common nation reforms to put the EU block of nations on heterogeneous footing in regards to regulation, debt management etc. This will go a long way to solving the problem at hand, but will also put significant strain on several of the weaker nations, again exacerbating the probability for restructuring to bring said nations in line with their stronger counterparts.

 

Impact of bank’s banking books on haircuts

 

EU banking book sovereign exposures are about five times larger than trading book. The table below gives sovereign exposure of major European countries for both trading and banking book. The EU trading book has €335bn of exposure while banking book has €1.7t exposure towards sovereign defaults. EU stress test estimated total write-down’s of €26bn as it only considered banks trading portfolio. This equated to implied haircut of 7.9% on trading portfolio with losses equating to 2.4% of Tier 1 capital. However, if the same haircuts (7.9% weighted average haircut) are applied to banking book then the loss would amount to €153bn equating to 13.8% of Tier 1 capital.

 

 

We have also presented an alternative scenario since we believe that EU stress test had failed not only to include banks HTM books but also the loss estimates were highly optimistic, as has much of the economic and financial forecasting that has come from the EU. It is highly recommended that readers review Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for a detailed view of a long pattern of unrealistically optimistic forecasting. Here's and example...

 

 

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Revisions-R-US!

 

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In an alternative scenario, we have assumed weighted average haircut of 10% (exposure, haircut assumptions and writedowns for individual countries are presented in detail in the tables below) and have applied writedowns on both banking and trading books with the results available in the subscription document  The Inevitability of Another Bank Crisis? Individual and more explicit haircut calculations are available for the following nations for professional and institutional subscribers:

 

• • Greek Default Restructuring Scenario Analysis
  • Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
  
  • The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers
• Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts

 

Interested readers can follow me on twitter and review our  

Comments

[disabledvet]

clearly your problem from day one is "you're not connecting to the folks" on this matter.  i gave up after being booted off Seeking Alpha for the upteenth time and have since devolved my analysis to a more "pragmatic" format: here's how the European Union is "going down" this time (the guy in the scary uniform is "the euro"):

http://www.youtube.com/watch?v=FDhGS4EJS8M&feature=player_detailpage

[Forgiven]

Reggie - I am confused.  To me it seems your "Macro Options" solution does nothing but paper over the freight train's tunnel.  It doesn't change the fundamental fact that a freight train is coming through that tunnel.  Let me put it another way, it's just a fancy way of finding a greater fool, right?

[old naughty]

It's a runaway.

[Popo]

...as if the USA hasn't already secretly agreed to bail the ECB out...

[Fix It Again Timmy]

How far can a rubber band be stretched?

[JustACitizen]

With the degree of implied leverage in the "world financial marketplace" - the "fantasy accounting" practices employed universally - Greece could trigger a 6 sigma event - no bonuses for bankers...you guys need to keep it real.

[falak pema]

Given that EU banking is tanking, your remark "EU banks remain weak as compared to their US counterparts" makes me wonder...The only reason US banks are not belly up is because USD is "reserve currency". Period. That's the fiction behind their "relative" health. If the FED tanks into an uncontrollable spiral they tank as well. The US central bank false mirror play is more powerful than ECB play. False-Bottom line.

[Doeko]

Jeebus, this whole Greece thing is getting ridiculous. Is it really the best the bears can do these days? Really? Greece? It's like saying a state default in Kentucky could cause the entire US government, the Federal Reserve, the banking sector and the lord knows what else to become insolvent.

Let me help you with a little realism. It's not 100% (but close to it) impossible that your scenario will happen, but (like the US government would do with Kentucky) the larger other member states are going to continue bailing out as long as the costs of these bailout are far below the result of not bailing out. With the Lehman collapse we've witnessed how high these costs run and if the Fed and/or the US gvmt had known them beforehand, the financial crisis would never have been allowed to happen in the first place.

The only risk in this situation is politically desperate morons like Merkel who would sacrifice everything for a few votes. If Merkel wasn't considering what the peons might vote in the next election there would be zero rhetoric on private involvement and the markets would continue to not give a damn about Greece. 

I expect Merkel is purely doing this in order to to be able to say, in the end, to her people that "she tried her best, but there really really really was no other way, sorry". It's really a smart trick because it may allow the German people to accept the bailout if they believe that it is the outcome of careful deliberation.

[sunny]

It was in 1930, I believe, when a not all that big of a bank in Austria collapsed, classic run on the bank brought them to their knees.  Fear then drove other banks over the edge.  These were not major players in international finance.  No matter.  This started the second and far larger drop in international markets and initiated what we now call the [First] Great Depression.  You write with such confidence that the collapse of Greece will not have a parallel impact.

Perhaps.  Perhaps not.

sunny

[williambanzai7]

The thing is this whole scenario is stretches out over a year so there has been plenty of political disgust fomenting. The politicians are under excruciating pressure so it is not so simple to conclude that the checks will fly out the door willy nilly.

And what is a dead certainty is some unknown unknown is lurking out there and getting ready to rear it's ugly head at the most inopportune time.

There are so many negative forces building and the politicians and institutions are helpless in reversing the momentum. This is what is extremely similar to the early Summer of 2008.

It is very much like watching a player getting cornered in a chess game.

[The Fonz]

I agree, I cannot think of anything which would return confidence to the market at this point. Due to that fact the expense of saving the market has changed, it is now more expensive to try to kick the can down the road than to crash a few banks. Control cannot be regained without a major correction, the people must be brought to believe the "change" has happened and the previous dance steps have been exhausted. I do not believe the powers that be are dumb enough to continue down this path without letting the market correct meaningfully to gain any real chance at sucessfully controlling the debt serfs.

[jon dough]

Y'all should read Garrett's "The Bubble The Broke The World".

And if you have I can only ask, how can the similarities be missed...?

http://mises.org/books/bubbleworld.pdf

That which has happened is happening again. Sovereign bailouts again and again only to result in the final crash that "Broke The World".

This time will be different, though...the crash will be on a scale that will make '29 look like a mild economic hiccup.

Fasten your seatbelts, kiddies.

[hungarianboy]

No, just watch till they pull Italy out the hat for some bearish news.

Greece is just the foreplay I think.

[Doeko]

Running around screaming the ECB is insolvent is a little more than "foreplay" and I think everything, including Italy, has pretty much been pulled out of the hat already.