Scott Minerd's Detailed Pre-Mortem On What Europe's Bank Run Will Look Like, And Other Observations

Tyler Durden's picture

We traditionally enjoy the periodic letters by Guggenheim's CIO Scott Minderd. His latest piece, "The Opening Act to the Broader Crisis" is no exception. In it, the strategist dissects the European crisis, compares it to the subprime debacle and sees it as the precursor to the eventual downfall of the euro, a surge in the dollar, the "federalization" of Europe and the adoption of QE by the ECB. The key must read item in the current report is Minerd thought experiment of what a  wholesale bank run, first in Ireland, and then everywhere else in Europe, would look like. This is especially important as one could, as Scott claims, start at any moment. What does this mean for investments? "If we are on the brink of crisis in Europe, which I believe we are, then there are several expectations we can draw about the investment landscape. First and foremost, the dollar will strengthen rapidly against the euro; U.S. Treasuries will rally; equity prices in Europe will fall; and credit spreads will widen, at least temporarily. In general, risk assets will experience choppier waters, especially as the crisis intensifies." Yet somehow this is a disconnect with the Guggenheimer's recent Barron's round table bullish statements on stocks and high yield bonds: "Let me be clear, I am not changing my mind on any of these investment theses, but a crisis in Europe will likely interrupt, but not derail, certain bullish trends at some point in 2011." It is ironic that Minerd brings up subprime as an analogy to Europe: after all his response is precisely the same that everyone else who appreciated the gravity of the subprime contagtion used at the time, starting with The Chairman. To wit "it is contained." All else equal, and it never is, we fail to see how a surge in the world's funding currency, the USD, will not generate an all our rout in every single risk asset, The Chairman's gushing liquidity notwithdtanding, due to trillions in short dollar funding positions.

Here is how Minerd, who obviously realizes this dichotomy, attempts to resolve this glaring irony:

To understand what this might look like, I use the analogy of the stock market in 1987. During the stock market crash of October 1987, the Dow Jones Industrial Average plunged 31 percent. For six trading days, it appeared that everything in the world blew up. Despite its crash that October, the Dow still ended 1987 up 2.26 percent for the year. Annual returns were 12.6 percent during the 1980s, and they surged even higher (15.1 percent) in the decade following 1987. From a historical perspective it doesn’t look like there was much of a crisis in 1987 after all. In 2011, I think the markets will face something similar with the pending crisis in Europe. At least for the U.S. market, at some point in the next year there will be a dramatic disruption that will adversely affect prices. In spite of this, I still believe equity returns will average 7 to 9 percent for the next decade.

So let's get this straight: the unwinding of the biggest political and socio-economic experiment of the last century, and the collapse of the world's largest economy (which is what the EU is), together with surging bond spreads, trillions in FX flows, an explosion in the dollar, the collapse of European trade is the same as a... one-time stock market event?


That said, Minerd does have some pertinent observations on how the imminent pan-European bank run will eventually look like.

‘Imagine You’re Irish’

To help explain why I believe a broader financial crisis is coming to Europe, let me start with a quick story. Imagine for a moment that you’re an Irish citizen. Needless to say, you have many concerns about your country’s economic situation. The unemployment rate is 13.7 percent and climbing, your economy continues to contract, your nation’s debt-to-GDP ratio is 97 percent and rising (up from 44 percent just two years ago), your national deficit has ballooned to a whopping 30 percent of GDP, your government is caught in a debt trap, and its borrowing costs have increased 75 percent year-to-date. If expressed in current market rates, the interest payments on your government’s debt obligations could easily account for 7 percent of GDP, or roughly one third of annual tax revenues. To put this into perspective, the situation facing the Irish government is akin to waking up everyday only to realize that one-third of your salary is gone before you even think about paying for the necessities of life.

Fiscally, everything is heading in the wrong direction in Ireland. However bad it may be, the country’s solvency is a secondary concern. If you’re an Irish citizen, the more pressing issue is what you’re going to do about your banking deposits. Your domestic Irish bank posted a 2.4 billion euro net operating loss in 2009 and is projected to nearly double its losses in 2010. The entire domestic Irish banking system has essentially failed, but the government wants you to believe that everything is fine. After all, the International Monetary Fund, the European Central Bank, and the European Union member countries have cobbled together an 85 billion-euro rescue package of which approximately 35 billion euros is set aside for the banking system.

In addition to the bailout, the Irish government has assured you that it will guarantee your deposits, therefore, there’s no need to worry.

Then you get a hold of the Central Bank of Ireland’s most recent Credit, Money, and Banking report (publicly available on the internet). You see that total deposits for Ireland’s dwindling base of domestic credit institutions were roughly 496 billion euros as of October 2010. Some quick math tells you that this is more than three times Ireland’s GDP, and 14 times the scope of the current banking system bailout package. You start to wonder, “If I try to get my money from the bank at the same time everyone else does, where is the government going to get the euros to pay everyone?” You can’t think of an answer. Then you start to feel silly. “Why am I even bothering with all this worry?” you ask yourself. “I’ll just go down to the bank and take my money out now before things get worse. I can give it to a multi-national bank and sleep better at night.”

It seems trite, but this little scenario is essentially what’s happening today. The Irish banking system is literally experiencing a run on its banks. According to the most recent banking update from the Central Bank of Ireland, total deposits in Irish banks declined more than 5 percent (28 billion euros) between August and October alone.

Year-over-year, deposits declined 10.5 percent, and foreign investors are pulling their money out at an even faster rate of just over 20 percent per year. If the October data was that brutal, I cringe at the thought of what the November and December numbers may reveal. Even more disconcerting, domestic deposits have begun to contract. It’s one thing for foreign depositors to lose confidence, but now even the domestic deposit base is losing faith.

Facing facts like these, each morning when I wake up I have to wonder, “Why is today not a good day for a wholesale run on the Irish banking system?” And if there is a wholesale run on the Irish banking system, then what stops the same scenario from cascading into Portugal, Greece, Italy, and most importantly, Spain?

So is there any hope at all for Europe? Yes...but to plagiarize from Goldman, with huge risks:

‘Where’s My Printing Press?’

Someone recently asked me, why doesn’t Ireland drop out of the EU and do what the United States has done with quantitative easing (i.e., run the printing press)? The problem in Ireland, Spain, Portugal, etc. is that they can’t print money – they surrendered the sovereignty of their printing press to the European Central Bank (ECB) long ago.

The next logical question is, why doesn’t the ECB just run the printing press for them? Can’t the ECB create a flood of euros to alleviate any concerns over illiquidity in the banking system and the toxicity of certain sovereign debt obligations? Technically they can, but practically they won’t. The psychology behind this is something that I hope to address in a future commentary. But for now, suffice it to say that dropping out of the EU is not a viable option for Ireland or any of the other debt-plagued peripheral countries. Benefiting from aggressive monetary policy is equally unlikely, at least to the extent necessary to stave off further crisis.

If Ireland and the peripherals can’t drop out of the euro, and the ECB won’t paper their way out, then what is the alternative? The answer most likely lies with the Germans. Since Germany is not willing to let the troubled economies secede from the euro, and they’re not interested in outright bail outs, the only option left is for the nations of the European Union to somehow share the burden. This would require greater fiscal union and ultimately translate into European federalization. Federalization may not seem very palatable at the moment, but the debate is certainly gaining steam. Once the crisis comes to a head, I could see the German people looking much more favorably upon playing a historic role in organizing the fiscal union of the sovereign states of Europe.

In simple terms, federalization means that the EU would issue pan-European bonds and begin the process of expanding the role of its central governing body over time (the EU already has a governing body with a formal president, currently Herman van Rompuy). This is what the United States did when it ratified the Constitution and established the U.S. Treasury, which in turn consolidated and absorbed the various debts incurred by colonies during the Revolutionary War.

I believe the federalization of Europe is the most viable solution and will be the ultimate outcome. As German Finance Minister Wolfgang Schäuble said recently, “Sometimes it takes a crisis so that Europe moves forward. In this crisis, Europe will find steps toward further unification.” As Schäuble subtly foreshadows, to get from here to there, the crisis will need to intensify. As sovereign credit downgrades continue to flow in and deposits in Europe’s weakened banking system flow out, a broader crisis in Europe appears to be imminent in 2011.

What this means is that the final lap in the great currency debasement race will start in earnest some time in 2011 as the last lever available to the EU has to be pulled:

With the great debaser, Dr. Bernanke, leading the way, the European Central Bank will eventually have to join the charge and print money in order to save the European financial system. As Hyman Minsky once postulated, central banks ostensibly say that their job is to maintain stable prices and sound monetary policy, but at the end of the day, the role of any central bank is to save the financial system at all costs. This includes the cost of the value of the currency and price stability. There’s nothing that cannot be sacrificed if the entire financial system is at risk. Practically, I believe this means that the euro will head to parity with the dollar and then ultimately below parity.

According to Minerd this means that a short EUR trade is a no brainer. That and going long core European CDS, a trade which we ourselves have been pushing for a long time:

The main theatre where the events in Europe play out will be in the foreign exchange (FX) market, where the primary opportunity is to short the euro. Outside of FX, I believe there are opportunities to buy gold and invest in U.S. Treasuries (but not just yet), as both will benefit from their safe-haven status once crisis erupts. In addition, there is opportunity to go long credit protection in the CDS of the countries that haven’t blown up yet, namely Italy, Germany, and France.

We disagree that a plunge in the EUR, which means a surge in the USD, can coexist with rising risk assets. It can't. There are literally trillions in USD funded carry positions whose unwind will result in a market correction that will obliterate the 666 lows on the S&P. There is simply no way that a drop in the Euro does not impair risk.

We end with Minerd's closing observations on that "other" most important topic - interest rates:

In December 2009, the yield on the 10-year Treasury increased 64 basis points to close out the year, primarily on the back of robust expectations for economic recovery (fourth quarter 2009 GDP eventually registered 5 percent annualized growth). Following the rise in rates in late 2009, the first quarter of 2010 saw rates go sideways. Then, after pushing upward to 4 percent in early April 2010, the yield on the 10-year proceeded to fall precipitously by 160 basis points over the next six months. Most recently, yields have mimicked 2009 year-end by climbing 80 plus basis points off the lows as positive economic expectations are taking root once again.

Although it would appear I’m describing significant fluctuation in rates over the past 12 months, at no point in this story did rates break out of the long-term down trend established over the past 30 years. In fact, even at the nadir of 2.21 percent on December 31, 2008, the yield on the 10-year note remained completely within trend. Even as we end the year with yields rising to what seem to be a relative high, the 10-year Treasury remains completely within the trend channel of declining longterm interest rates.

I’ve already gone on the record saying that the bull market in bonds is long in the tooth, but it’s also important to note that bull markets don’t just roll over and die – they either break trend and continue into a parabolic blow off, or they break the trend and move sideways for long periods of time. To me, the most important point is that the recent rise in interest rates has yet to break out of the downward secular trend in bonds. This event would be the first indicator to watch for before anyone should be concerned about rates rising in a meaningful way, and it has yet to materialize. I suspect that in the near term we’ll see continued upward pressure on rates, but I would be surprised if they reached much higher than 3.80 on the 10-year note before declining again. The moral of the story is that as we near year-end, the 10-year note remains approximately 45 basis points below where it started the year.

After a tumultuous 2010 filled with rising-rate speculation, the case for an extended period of low interest rates remains faithfully intact.

Full report here.

h/t momo "I am hiding a sock in my pants" trader

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Alfred's picture

"Pre-Mortem"... freakin' genius!

HarryWanger's picture

Gee, I wonder if it will be as "horrific" as the Irish bank run on 12/7? Pretty much crippled the country. Oh, it didn't? That's right, another "horror" story that didn't come to pass.

Gully Foyle's picture

Careless Whisper

Definitely far less worse than Spiderman the musical and it's curse.

Gotta admit Lohan does have a knack for staying in the media unlike say Tom Sizemore.

Careless Whisper's picture

the controlled media force feeds us lindsay stories as a distraction to the important news, but people are seeing through that, or at least viewing important news along with the daily nonsense.


LowProfile's picture

Not as many people want to hate-fuck Sizemore.

Lord Welligton's picture

The ECB and the Central Bank of Ireland have "lent" €135bn to Irish banks.

That's over 100% of Irish GNP.

M.B. Drapier's picture

And €44bn+ of that is Exceptional Liquidity Arrangement money from the Central Bank of Ireland. Unlike other ECB/Eurosystem "liquidity" programs like the LTRO repos or the SMP bond-buying, the Irish taxpayer is on the hook for any and all losses from Irish ELA "liquidity".

crazyjsmith's picture

Patience Wang Chung, Patience.  Or did you not read the multiple references to "2011"? 

Rarely does one die immediately when diagnosed with a terminal disease. 



flacorps's picture

A pre-mortem is a terminal diagnosis. No need for a neologism. My neologism of the year is "plutocronyistikakistocracy."

Oh regional Indian's picture

That sounds like a neologism straight out of the mouth of GI Gurdjieff.

Very good.

10 points.


Gully Foyle's picture


Doctor: [laughs] Right, kick ass. Well, don't want to sound like a dick or nothin', but, ah... it says on your chart that you're fucked up. Ah, you talk like a fag, and your shit's all retarded. What I'd do, is just like... like... you know, like, you know what I mean, like...

cosmictrainwreck's picture

excellent recall, Gully! scene ends, as I remember, with the doc freaking out: "unscanable! unscanable!" perhaps prescient.....

metastar's picture

plutocronyistikakistocracy, ... WTF???

UncleFurker's picture


Why would the USD rally?

Are the US banks exposed to a european crash?


Spalding_Smailes's picture

The dollar is going up because the USA will have 3.5-4.0 GDP next year. The euro is in trouble because they built many nations around one interest rate, Germany is booming & needs a rate hike. The pigs and the rest need ultra low rates, this will end bad. The US dollar being the reserve currency always has a bid, old debt being rolled over ( can kick ), new debt being issued on a global scale every day, businesses ect .... The USA running at 70% is still a powerhouse.

Sean7k's picture

As long as GDP numbers include government expenditures, they are compromised. They require an additional tier of analysis. The proportion of public versus private product becomes an important ratio. This ratio is climbing in favor of public spending. With the addition of city and state fiscal failures looming- this could get very ugly, very fast. 

This will be the cover used to prop back up the euro and the dollar will then slide. The Yen will follow and we will continue the spiral downwards. Asset prices will mean nothing by themselves  because currency values are compromised. Ratios of assets will be necessary to determine any real winners. 

DoChenRollingBearing's picture

Almost everything I read (here and elsewhere) convinces me that it all is going to end badly and the only protection we individuals have is gold (etc.).

akak's picture

I agree, DoChen --- all this talk about a "rising dollar" and "flight to safety in the dollar" is just more smoke and mirrors attempting to hide the ultimate truth --- the depreciation and ultimate collapse of ALL fiat currencies, and the corrupted and unsustainable Ponzi-like markets and financial structures built around them.

Id fight Gandhi's picture

You can't expect GDP that high when the world cannot buy your goods. GDP today even missed expectations. You're way off.

Germany is screwed being part of the euro. Only country over there doing anything or producing,

DosZap's picture

Germany won't be screwed, they will (IMHO) dump the Euro, and go back to the Mark.

Prior to taking a major bath.If they do not their citizens will burn them down.

Gully Foyle's picture


Phone Computer: Welcome to AOL Time Warner Taco Bell US Government Long Distance. Please say the name of the person you wish to call.
Rita: Upgrayedd.
Phone Computer: There are 9,726 listings for "Upgrayedd". Please deposit $2,000 to begin connection.

Spalding_Smailes's picture

BankofAmerica is up 7% this week. Should be up 25-35% by next July.... easy money. The new gold.

tmosley's picture

Take a look at a five year chart of each and then hit yourself in the head for being so stupid.

Actually, let me help you:

cougar_w's picture

Shorter Scott Minerd: "The Eurozone is baked. The Bernank will shortly reach for a bigger hammer. And as ever, buy the dip."

TWORIVER's picture

Harry where are you planning to sell AAPl or SPY. What targets do you have?

HarryWanger's picture

I believe that AAPL will hit 400 early next year. I am trailing it with a fairly tight stop (2% below current price) as it moves higher. 

As for SPY, I am not holding it but don't think you have to worry about it until SPX reaches 1285-1290 level. That might be the next logical point for a shallow pull back.

VegasBD's picture

"This is not the Harry you are looking for."

downrodeo's picture

Shoot, where is HamyWanger?

I want to see those two in the same room at the same time...

samsara's picture

Come'on Wang,   Stops are for Pessimists

TWORIVER's picture

Harry where are you planning to sell AAPl or SPY. What targets and stops do you have?

elagano's picture

I just hate when people post charts that are not to scale.

Beam Me Up Scotty's picture

So, today I have read 2 articles about society going cashless.  How does one make a run on the bank then?  Or will the sheeples debit card cease to function one day?? 

Sean7k's picture

Germany finds it can conquer Europe, without firing a shot. The world no longer needs a military- we only require central banks and a measure of trust.

virgilcaine's picture

"We disagree that a plunge in the EUR, which means a surge in the USD, can coexist with rising risk assets. It can't. There are literally trillions in USD funded carry positions whose unwind will result in a market correction that will obliterate the 666 lows on the S&P. There is simply no way that a drop in the Euro does not impair risk".

beauty. I'm expecting undorderly declines across the spectrum.  Like that word unorderly. Fits with the times.



RobotTrader's picture

As usual....

The worse the problems in Europe....

U.S. retail stocks get even stronger....

Europeans are now cheering because their U.S. common stock investments are skyrocketing.

The retail index remains pinned at the highs, unable to sell off.

HarryWanger's picture

Average Joe and Jane couldn't care less about Europe, and rightly so. What they are seeing is job security and a new found sense of relief that we will be just fine here. That has led to a strong buying binge, hence retail stocks flying.

jus_lite_reading's picture

BWAHAHAHAHAH! "Harry Wanger" is a pseudonym for Ben Benanke or Obama!


What they are seeing is job security and a new found sense of relief that we will be just fine here. That has led to a strong buying binge, hence retail stocks flying.

Tyler Durden's picture

Funny you should say that, as it is precisely indicative of the level of ignorance among the broader population. Job security? Yes... if one equates a part time job with security.

Luckily, most people in America are not as stupid as you suggest and realize that the recovery is a "part time" one based on unrepayable government leverage.

Charting America's Transformation To A Part-Time Worker Society, Following 6 Straight Months Of Full Time Job Declines

HarryWanger's picture

Luckily, most people in America are not as stupid as you suggest and realize that the recovery is a "part time" one based on unrepayable government leverage.

You are dead wrong on that assumption. Look, I have seen discretionary spending this past Q surpass even our strongest years of 2004-2007. Either people are as "stupid as I suggest" or they are very comfortable with their economic situation. Based upon the discussions I've had with clients and distributors, Joe and Jane are as comfortable with their job security as I have seen in years.

malikai's picture

I think Joe and Jane have been sipping too much eggnogg. I think it will all come crashing down shortly. But first, let's party!

DosZap's picture


Bingo, Americans are largely children mentally.

They have pulled in their horns, paid down their debt, and now, are spending again, those that can, with abandon.

One LAST FIX, after 2yrs of self imposed austerity, and debt paydowns they think they DESERVE some good TIMES.

They will get it, Big "0" will get credit, and we all go back to the real world.

Broke as a dead dik dog.

downrodeo's picture

Of course, it could be the case that your personal experience is not indicative of the overall behavior of the nations economy. I'm sure you've considered that though...

Sean7k's picture

3RD quarter GDP shows personal expenditures are down and inventories are up. I know you like to shill, but it would improve you're standing if you knew when to shill and when to shut up.

tmosley's picture

Either you are a liar (something I am inclined to believe, as you a literally a professional troll, writing papers on the "psychology of permabears"), or your business is being buoyed by spending from federal workers.

My area was the last one into the depression, and should be the first one out, as we have (relatively) outstanding governance here.  There is no recovery here.  Unemployment remains high.  No-one but the "ultra rich" are spending.  New businesses are not opening up.  Existing businesses are not hiring.  On the rare occasion that I have been hiring, I get more applicants each time.

So yeah, your story is just that, a story.  Fiction.

Panafrican Funktron Robot's picture

Spending data. Most recent available was 12/17/10. People are spending about $70 per day. For 12/17/2009, people were spending about $73 per day.

Point being, you're completely full of shit or extremely ignorant.

crazyjsmith's picture

WOW WangChung, you even got TD to post a comment regarding your ignorance.  Congrats!!  Nothing like a little bit of Chart Therapy to slap some reality back into the conversation.



akak's picture

You are dead wrong on that assumption. Look, I have seen discretionary spending this past Q surpass even our strongest years of 2004-2007. Either people are as "stupid as I suggest" or they are very comfortable with their economic situation. Based upon the discussions I've had with clients and distributors, Joe and Jane are as comfortable with their job security as I have seen in years.

Fuck you, you utterly lying piece of shit troll, if you expect ANYONE here to believe such complete and total, wildly absurd bullshit.  There are permabulls, and then there is permabullshit.

steve from virginia's picture

Largest increases in US income has been in exports (weak dollar) and in defense outlays. With a $80 billion restructuring of Department of Defense (DOD) this year cuts will be felt in the DC area which is heavily invested in defense and security businesses.

The DC area is looking @ 15- 20,000 DOD- and related layoffs along with local government cuts. What the Feds will do to/with Fannie/Freddie is also a question mark. Restructuring these entities will cost 20,000+ jobs and more downstream.

This area has long been considered 'recession proof' because of the immense Federal presence but real estate values have declined 20% since the 2007 peak. Many government related tech contract jobs have been lost. Construction is down + 50%. Commercial RE has the highest vacancy rate since 1990's recession w/ retail sector bombed except in a few 'high end' locales.

High fuel and food (embedded fuel) costs are diverting funds from other consumables. There is no comfort here, only increasing anxiety as people realize the District area is no different from anywhere else in the country.

Please keep telling us how things are in Beverly Hills.