ZeroHedge, in its snarky, smart ass, Reggie Middleton-like manner made me chuckle this morning with this headline: Mario Draghi Sends Risk Reeling After Exposing Bitter European Truth
It was shaping up like the perfect overnight ramp following yesterday's Goldilocks election result... and then Mario Draghi opened his mouth.
- DRAGHI SAYS DEBT CRISIS STARTING TO HURT GERMAN ECONOMY
- DRAGHI SAYS GERMAN RATES LOWER THAN THEY WOULD BE OTHERWISE
And so finally, after months and months of explaining the fundamental dichotomy in Europe (see here), it is finally becoming transparent. And it is as follow: Germany, which is the economic dynamo of Europe, needs a weaker EURUSD to keep its export economy running. Period, end of Story. The problem is that the lower the EURUSD, the greater the implied and perceived EUR redenomination risk, which in turns send the periphery reeling, and will force first Spain, and then everyone else to eventually demand (not request) a bailout.
A quick search on the topic reveals much more of the same...
I emphasize this point because this problem was woefully evident nearly a dull year ago. On Thursday, 12 January 2012, after railing on the US education system (How Inferior American Education Caused The Credit/Real Estate/Sovereign Debt Bubbles and Why It's Preventing True Recovery), I made clear to all Harry Potter aficionados (you know, those Euro-types who would rather believe magic over math) that biggest threat to the 2012 economy was sitting right beneath their noses couched as a savior more than a threat. Reference The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You..., wherein I painstakingly took the tie to attempt to reassert the authority of math over magic. With the exclusion of central bank mysticism and the attrition of the belief that these bastards can create something out of nothing, or more to the point, can drive nearly everything towards nothing and then suddenly state that they have created something, I bring you my warning prescient warning on Germany and the macro-fundamental call to be aware of the bear Bund trade, to wit:
I believe Germany poses the biggest threat to global harmony for 2012. Here's why...
European banks are (in addition to borrowing on a secured basis from those customers they usually lend to) also paying insurers and pension funds to take their illiquid bonds in exchange for better quality ones, in a desperate bid to secure much-needed cash from the ECB, which only provides cash against collateral. This may not be as safe a measure as it sounds. Below is a sensitivity analysis of Generali's (a highly leveraged Italian insurer, subscribers see Exposure of European insurers to PIIGS) sovereign debt holdings.
As you can see, Generali is highly leveraged into PIIGS debt, with 400% of its tangible equity exposed. Despite such leveraged exposure, I calculate (off the cuff, not an in depth analysis) that it took a 10% hit to Tangible Equity. Now, that's a lot, but one would assume that it would have been much worse. What saved it? Diversification into Geman bunds, whose yield went negative, thus throwing off a 14% return. Not bad for alleged AAA fixed income. But let's face it, Germany lives in the same roach motel as the rest of the profligate EU, they just rent the penthouse suite! Remember, Germany is not in recession after a rip roaring bull run in its bonds, and I presume the recession should get much deeper since as a net exporter it has to faces its trading partners going broke. Below you see what happens if the bund returns were simply run along the historical trend line (with not extreme bullishness of the last year).
Companies such as Generali would instantly lose a third of their tangible equity. This is quite conservative, since the profligate states bonds would probably collapse unless the spreads shrink, which is highly doubtful. Below you see what would happen if bunds were to take a 10% loss.
That's right, a 10% loss in bunds translates into a near 50% loss in tangible equity to this insurer, which would realistically be 60% plus as the rest of the EU portfolio will compress in solidarity. Combine this with the fact that insurers operating results are facing historically unprecedented stress (see You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses!) and it's not hard to imagine marginal insurers seeing equity totally wiped out. The same situation is evident in banks and pension funds as well as real estate entities dependent on financing in the near to medium term - basically, the entire FIRE sector in both European and US markets (that's right, don't believe those who say the US banks have decoupled from Europe).
Now, all of this excerpt above was written BEFORE Tropical Storm Sandy hit the east cost. Now, its a whole difference ball game in terms of combined ratios and operating losses. Exactly how are those operating losses are going to be paid once the truth becomes widespread, re: Germany vs the periphery?
Second: Go long magic wands and Harry Potter paraphenalia!!! Or...
The damage to banks will probably be worse due to the higher level of leverage in European institutions. This is saying a lot since Italy's Generali is truly levered up the ASS! As excerpted from our professional series (subscribers see Bank Run Liquidity Candidate Forensic Opinion:).. (click here to continue reading)