Commentary On "Is Another Banking Crisis Inevitable?".

This is a contributing European CDS trader's commentary on the BoomBustBlog research piece "Is Another Banking Crisis Inevitable?".

Note that this opinion was written before the rating agency vs. ECB/EU soap opera
of this past weekend which essetially proves what we presented to our
pro subscribers early last year - a zero coupon rollup created to
restrucuture debt is..... a default! Reference Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts and What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates
- both written over a year ago, and both quite prescient. In the
meantime, enjoy this guests contribution, annotated as usual by yours
truly!

---

At this stage i have a remark/question in your
« the inevitability of a banking crisis »(dated when?) you were waaay
too optimistic (!!) seeing 172bn of losses related to PIIGS. We may be
over that only on Greece exposure!

Certainly, if we compare
the fiscal trajectory of the Eurozone as a whole with the US, the US is
not really on a better path. Austerity has started in Europe. US seems
still in full spending spree.

I would argue as long as there is no
bank run and voluntary secession, things even if shaky, will stay more
on less under control by governments. Being anti-Euro can win elections,
and there is a real chance that some country (Greece, Finland...) quit
the Euro by themselves for not wanting austerity or not wanting to bail
out other countries. But so far, its just talk. In Portugal they voted
out the PM, well they still got austerity...Ireland is a total joke as
well.

So if we step back, and ask ourselves who's going to buy this ever growing govt debt, well this is the banks of course !

Look
(I didnt!) at the balance sheet of Japanese banks 20 years ago and now,
many JGBs in their balance sheet, in place of those turned sour (real
estate) loans...every $ or euro spent from the budget, ends up in a bank
account, and the ALM officer of that bank, well, the only stuff he can
buy with it, is a govt bond as its the only « safe » asset (what else
would be ? Even if they bought all those google bonds...)

Well,
if you take a look at how well that technique turned out for the
Japanese banks, a widespread, long term bear trade on the banks may not
be that bad an idea, despite how obvious the trade may be!

..
It is the reporting company’s responsibility to report, not to
obfuscate. The big problem with this “hide the market marks” thing is
that markets tend to revert to mean. Unless said market values
fundamentally catch up with said market prices, you will get a snapback.
That is what is happening in residential real estate now. That is what
happened in Japan over the last 21 years!!! That’s right, it wasn’t a
lost decade in Japan, it was a lost 2.1 decades!

This
has been the first balance sheet recession that the US has ever had,
but there is precedence to follow. Japan had a balance sheet recession
following their gigantic real asset bust. They made a slew of fiscal and
policy errors, which essentially prolonged their real asset recession
(now officially a depression) for T-W-E-N-T-Y  O-N-E long years! For those that may have  a problem reading that, it is 21 long years. What did the Japanese do wrong?

• They refused to mark assets to market
• They attempted to prop up zombie banks
• They failed to promptly clean up NPAs in the banking system
• They looked the other way in regards to real estate value shenanigans

Now,
for those of you who believe that the government's "pretend and extend"
policy has any chance in hell of working, or better yet, that we are
not following in the footsteps of Japan, let's take a pictorial trip
through recent history. There are nearly no Japanese banks in the top 20
bank category on a global basis by 2003 – NONE (save potentially
Nomura, which arguably survived in name, alone). As you can see, they
literally dominated 90% of the space in 1990!

Click to enlarge…

Source: Cap Gemini Banking M&A

...
and well if the ALM officer doesnt buy those bonds, and buys something
else, the money just ends up in another bank which will buy those bonds !

The system is full circle...there is no flaw as long as people keep their money in the bank.

Hmm,
I'ver heard this argument before. This is not just a European
perspective. Many in the states believe this is doable a well, reference FASB Appears to Have Bent Over For The Final Time & Accuracy In Financial Reporting Dies An Ignominious Death!!!More importantly, let's explore this full circle theory as exerpted from Do
Black Swans Really Matter? Not As Much as the Circle of Life, The
Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!

As excerpted from Do
Black Swans Really Matter? Not As Much as the Circle of Life, The
Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!,
Bernanke et. al. have snipped the chrysalis of the US markets and
economy one too many times. He has interrupted the circle of life...

I
have always been of the contention that the 2008 market crash was cut
short by the global machinations of a cadre of central bankers intent on
somehow rewriting the rules of economics, investment physics and global
finance. They became the buyers of last resort, then consequently the
buyers of only resort while at the same time flooding the world with
liquidity and guarantees. These central bankers and the countries they
allegedly strive to serve took on the debt and nigh worthless assets of
the private sector who threw prudence through the window during the
“Peak” phase of the circle of economic life, and engaged in rampant
speculation. Click to enlarge to print quality…

The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. All four corners of the globe are currently “hobbling along on one leg”, under the pretense of a “global recovery”.

In the worst case, banks leave their money in the Central bank which will underwrite bonds.

Thats
also why Greek bonds being eligible to the ECB is a key political
issue. As long as they are, the ECB can provide money against those
bonds... Govts havent printed money directly so far (if they did, no
more need to issue bonds, just issue money with no interest...), just
bonds that can be repo-ed to the CB and thats really when money is
created.

Right on point, as reported by ZeroHedge over the weekend: As ECB Finds Rating Agencies Have Suddenly Found Religion, It Prepares To Flip Flop On Accepting Greek Bond Collateral

Doomsayers
have been saying for 10-15 years that the Japanese financial  system
would collapse, well the game is still on, and could last another 10-15
years (or more, or less, i dont know !). To me its really a game of
confidence. Indeed, if there was a real Greek default and bank runs,
then it would sure have a strong impact on the public, and we could have
a chain reaction, and thats what i think the European politicians want
to avoid #1. cause if they can, the zombified financial system can
muddle through for years.

Yes,
but as you can see from the charts and graphs above, the kick the can
methodology or reality rendering didn't necessary work that well for
real asset pricing or Japanese bank global presence, valuation or
competitiveness.

So where does this leave valuations and the European banking system ?

Well, on one hand we have this insolvent system, that tries to survive. But there are institutions too weak to be saved.

Bank
of Ireland, RBS, … show the way... well end up having more and more
govt participation and regulation. In some countries, the whole
financial sector might end up being nationalized. Financial sector is
dead. It used to be 10%-15% of the equity market capitalization, went up
to nearly 40%-45%. on that metric alone, there is much room for
downside (perhaps another 50% with the same level in the broad index).
Basel III, even if its not enforced yet (and perhaps by the time it
should there wont be many private banks left in Europe...), gives a
clear message: banks need to raise a lot of equity. And that needs a
discount as many banks need this money, the new business model will be
less profitable because of less leverage. Banks will try to hike fees,
and merge to save costs.

Maybe if we see some spectacular
failures, we will see a big transformation, especially with new entrants
focusing just on deposits and payments. In Europe, banks are
« universal » you tend have your account, your credit card your
mortgage, your car loan, your brokerage account with the same
institution. In my opinion it would make a lot of sense for Carrefour
(for example) to open a banking operation.

Or enter Glass-Steagal - Euro edition!!!

Because
of this increase for competition and diminished returns (less demand
for loans)... the only « business » which will be growing in banks, will
probably, their ALM !! Where they will buy more and more govt bonds
(and BASEL III makes sure their risk weightings are 0% and that they
have to do so for their « liquidity coverage ratios » (LCR) so they
favour those bonds. This will push yields down, and bank profits down as
they have to buy more and more of those bonds to try to keep the same
profits. EFSF or any kind of Euro bond would definitely be bought with
no problem.

And
here we go again! What happens when assets held as risk free (zero risk
captial weighting) at 30x to 60x levereage are truly nothing of the
sort. This exacly how a tiny economic entity such as Greece (whose
economy is probably smaller than that of Brooklyn, and definitely
smaller than that of the NY metro area) has managed to gut the entire
banking system of a plethora of 17 separate countries and much of the
continent. Reference:

1. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!

2. Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe

3. and finally How Greece Killed Its Own Banks!

With govt yield downs the extend and pretend game can last for many more years.

That
wouldnt prevent banking stocks to go further downhill, as it was the
case in Japan, but it might not be a one-way street, and peripheral
banks are not necessarily the ones who would suffer most from here in
the long run (after all if the crisis is resolved, their underwater govt
bonds will be reboosted). And both you and I know that banks know how
to twist and inflate their accounting, and that theyre showing profits
on what really are losses...

No!!!!! Say it ain't so!

Perhaps another nice short would be the insurance industry.

Been there, done that - Sovereign debt exposure of Insurers and Reinsurers

They
might be hurt even more than banks, especially life insurers...
especially it has benefited (in France) of a lot of tax rebates /
subsidies, which enticed the public into it, and if there is a sovereign
accident, I can smell a run there. (I myself cancelled my life
insurance, and all the « smart » people around me did so as well.)

All
in all, I think it was a great call so far to foresee the European debt
mess. But I think its much more tricky for here to make bets. Even the
EURUSD trade which looked as a no-brainer at the start of 2011 given how
dire the situation was, proved to be much of a pain...( to be honest, I
lost myself quite a lot on that one). that should be a warning signal
to me that things arent that simple.

As I got gaffed on the
artificial bank runup of 2009/2010. You see, the fundamentals have been
marred by central planning of the markets on a global basis. Again, I
request you reference Do
Black Swans Really Matter? Not As Much as the Circle of Life, The
Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!

Click here for relevant BoomBustBlog European Research from last year and here for current European opinion.

Comments

[bank guy in Brussels]

Reggie - A new EU report not only about matters in Europe with some discussion of the banking crisis, but about the role in robbing European banks of one of your favoured companies, Google, Inc.

Reggie, I have friends at the European Commission, and I have talked to them about this. I can tell you they are definitely NOT liking Google - that is really understating it - as they realise Google has been censoring internet searches in Europe and Brussels itself, to directly deceive EU authorities ... not to mention help rob European banks and businesses out of billions of euros ... you know how government authorities can react when they realise a company has been playing them, deceiving them, and gaming them, like Google has been doing.

The EU is going to hit Google hard over the whole set of numerous cases here, with this now included as the most blatant anti-EU crime of all ...

Imagine Google Inc. after being hit not just with a maybe 2 billion euro fine, but also everybody in Europe knowing that Google has been censoring EU searches to rob them and to even help murder Europeans and to silence journalists ...

Maybe a little 'impact' on Google Inc.'s place in the world, perhaps?

Some excerpts from the article publishing the report to the EU, and a link to the full version:

« Report distributed today to the EU Commission and EU Parliament ... charging dominant EU search engine Google with multiple offences and criminal acts against EU citizens and EU authorities, and with Google internet search censorship to deceive EU officials and even to help murder EU journalists.

... quite shocking, but has many links to evidence files and relevant sources, making for a devastating indictment of Google Inc. before the European Commission. Google faces a possible € 2 billion plus EU penalty, and perhaps other sanctions, for the crimes and offences detailed

Report to the EU Parliament and the Commission of the European Union

Anti-Competition Crimes of EU Internet Monopoly Google Inc., to Erase EU Journalism

... anti-competition crimes of Google Inc., to erase EU journalism and block freedom of EU internet communications; ... with Google Inc. engaged in billions of euros of fraud against EU businesses and citizens; with Google engaged in direct deception and fraud of the EU Commission and EU Parliament, censoring websites which are accessible via Google search in Brussels ...

- Google 'Internet Gas Chambers' erasing EU Journalism, to deceive and defraud EU business, EU banks, and EU citizens out of billions of euros;

- Google 'Internet Gas Chambers' erasing EU Journalism, in a direct attack on the European Commission and European Parliament, Google censoring and controlling Google search results in Brussels, to hide information valuable to EU authorities; and encouraging threats of harassment, extortion and murder against EU officials, which may expand as Google Inc. continues service to US political mafias;

- This a case of anti-competition crimes by EU monopoly Google, more important than related Google anti-competition offences against Foundem, ejustice.fr, Ciao!, or other victims of Google search engine discrimination, this being a case of Google Inc not just lowering search rankings, but entirely exterminating an EU journalist's work ...

- Even a penalty fine of 2 billion euros, may be insufficient ...

- What is very likely necessary here, is forcing a break-up of Google Inc., so that Google Inc. operates a subsidiary on EU territory, with Google Inc. providing guarantees that it will no longer censor EU journalism or other politically-related websites ...
and further that Google Inc., for the next five years or some other period, be forced to disclose prominently in large letters on all its search pages, that Google has been guilty of the crime of manipulating and erasing search results ... »

http://www.indymedia.nl/nl/2011/07/77181.shtml

[Eternal Student]

An unfortunately real and honest appraisal, indeed. I do note that there is one issue with using Japan as a model. They are a net exporting nation, and had lots of savings. The US has been a debtor nation with not nearly the same cushion.

Reggie: Don't you think this has an impact on the outcome, particularly as to shortening the timeframe?

[Lucius Corneliu...]

This has been the first balance sheet recession that the US has ever had,

It is not the first balance sheet recession.  The Great Depression was also a balance sheet recession which had a quicker resolution (a deflationary bust).  However, the speculation (and leverage) was mainly focused on stock margin accounts; but also consumer debt and RE.

[carbonmutant]

Trying to get growth without a contraction phase is like trying to get a rally without a short squeeze.

[hooligan2009]

On the basis that it is easier to ask soemone who already knows, rather than spend hours looking through the accounts of major banks...can someone tell me the exposure of the major US, UK, Canadian, French, Japanese and German banks to the sovereign debt of each of the PIIGS.

Thanks in advance, it will save a lot of rooting around. I know someone has done the work already, probably in the context of the US' or ECB "stress tests" 

[Popo]

Hooligan:  Here are the top 40 banks exposed to Greece.   Not all the PIIGS,  but it's a start...

http://www.zerohedge.com/article/barclays-releases-updated-report-top-40...

[hooligan2009]

thanks !