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On EU banks, Solvency or Liquidity? - Or BOTH?
I look at the financial statements of the big banks. 10-Qs and the like. I’ve concluded that, for the most part, it’s a waste of time. There are usually 70 or so pages of numbers and discussion. Tons of data. But what is missing is a realistic appraisal of what the assets are actually worth.
Rather than go blind looking at small print I just look at market capitalization and assets. The balance sheet assets are a good proxy for what has to be funded. The market cap (shares outstanding X current market price) is the only number one can look at that is “real”. It is real because the “tape” and the market say so. It is a much more reliable number than what the accountants, auditors and management tell you.
Market cap is critical because there is a presumption that a big bank can go to the equity market and issue preferred and common stock equal to about 10% of the existing market valuation. A big equity valuation is a cushion in troubled times.
Societe Generale, Paris is a big bank that has been much in the news this week. SoGen is a top tier global bank. They have a very large deposit base and consumer business. They are also a big global trading bank. SG is well managed. I would call it one of the Crown Jewels of the financial picture in France. It is a classic Too Big to Fail.
Having said all those nice things about SoGen I also have to point out that it has a very thin margin of market valuation to support its huge balance sheet. The market cap/asset ratios for SoGen, Wells Fargo and JPM:
Looking at this one sees the problem. SoGen is levered 4-6 X’s the US banks.
Under normal circumstances my way of looking at things is irrelevant. It only becomes significant when there are problems. Today we have problems.
There are monstrous gobs of liquidity in the world. But every day that goes by that liquidity is getting more and more risk adverse. Globally there is about $60 Trillion of funded debt of one form or another. That huge amount has to be rolled over constantly. A very substantial portion of this has maturities of less than six months. It is a “faith based” system. The assumption is that there will always be ample liquidity from the holders of cash to roll over everything without a hiccup. At the moment there is not much faith in that system.
The nice folks at FTAlphaville put up this interesting chart Friday afternoon. It tells the story perfectly. Everything is green except the month of August and the very short end of the funding spectrum. The red area is a Short Squeeze. This is also a big Red Alert!
The lower the equity cap of any financial, the greater the risk that there are funding problems. This is what did in Lehman. Almost overnight they lost their funding sources. (Note: This is what happened to Drexel in 1989. I was there. It took ten days to go from soup to nuts.)
SoGen, being what they are, will not be the first bank to suffer liquidity problems. I used their equity numbers to make a point. It is the second tier Euro banks that are going to get squeezed. I have no doubt but they are already feeling the pinch.
I can’t see this going on much longer. We may have already passed the point where the downward spiral on funding availability is irreversible without global central banks stepping in.
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That brings us to Jackson Hole. Damn near everyone I read is thinking that Bernanke is going to pull a rabbit out of his hat next weekend. Some new form of monetary stimulus will be announced and all will be well for the markets once again. I don’t agree.
While the US has some major league problems, those issues can’t be addressed by the Fed. There is nothing more that the Fed can do. With short-term rates at zero (and planted there for years to come) and the ten-year at 2% there is nothing left to be done. Or is there?
I maintain the next move by the Fed is to massively open up the dollar swap lines with European central banks. I don’t think Bernanke wants to announce this significant step at Jackson Hole. It is an EU issue and the Fed can’t take the lead on this. Opening the swap lines will prove to be very unpopular in the US. Politicians will jump on it as a bailout of Europe while America is struggling.
Bernanke is going to take some heat, when this happens (I think this is now a certainty, just not sure of the timing). But I also think that Bernanke is pushing (as I write) for this to happen. The only option left for Bernanke is to put another half trillion or so into the global system. He can’t do that in the US, but he has a great excuse today to do it in Europe.
I maintain the forum for this is not Jackson Hole. There is too much theater in all of this already. The Europeans don’t want this to be a circus (more than it already is). They want to be seen as responding to an EU problem, they don’t want to be seen as a slave to Bernanke and the Jackson Hole confab.
The announcement of the swap lines will not come from Wyoming. It will happen on a Sunday night. It either happens before next weekend, or the weekend after. Given that things are rapidly unwinding in the EU funding markets I don’t think they want to wait another two full weeks to put a band aid on the problem. They have to do something sooner than that. If they don’t, they risk a full scale liquidity blowout before September. If the blowout were to happen it would be very difficult to reverse. They have to (attempt) to get ahead of the problem before it is a crisis.
I think there is a decent chance this important next step takes place outside of Jackson Hole. It could happen this Sunday night. If I’m wrong, and we get nothing, the European funding markets are going to collapse next week. It will be very difficult to reverse the damage that this will cause. All the central bankers know this. They know that there is not much time left to act. They can’t wait another two weeks.
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Dear metastar,
"Either you're with us, or you're with the financial terrorists."
This is the dumbest thing I've ever heard on ZH---sorry, but this attitude is exactly why we could never come together and change our ways, imo. Most people do not have the capacity to admit that this problem is as profound as it is----they simply CANNOT believe it!
All I want to say is that 'for or agin' is not just inflammatory and counterproductive for change, but dis-respectful to about 90% of the US population without the necessary capacity.
There are times when I say the same thing to this oldman, however
respectfully om
Bruce, I've been following your liquidity posts with interest, thank you. I have a number of newbie type questions if you or anyone wants to answer, thanks in advance.
Is there much hope the liquidity problem can be completely fixed or are we hoping for a good kick of the can
I imagine when a freeze happens it will be fast. What can we watch to get a clue it's imminent? I've been keeping tabs on the Eurodollar LIBOR and LIBOR-OIS spreads creeping up but don't know if I'm wasting my time.
If/when a freeze happens what gets hurt the worst and what weathers the storm the best? I've made my own list but I may be making stupid assumptions.
Dollar up, at least short term
Market, financials down sharply
Bonds up short term?
Cash is good, especially the paper in your hand type.
How will the credit card companies fare if they can't get access to funds?
I say cash. Why? (1) No downside in the short term. 2) Dry powder if the SHTF. I missing out on potential upside. I'm happy with that for now.
CC receivables are funded short term by the holders of the IOUs. This is the funding that is now running for cover.
Is this a disaster for MC etc.? No, it is a disaster for those who hold the IOUs . That is the banks and the shadow banking system.
Bruce, you and Reggie should team up ;)
You guys are the 2 smartest guys out there.
Sometimes my brain hurts when reading Bruce or Reggie. The learning curve is a bitch. Thank you Bruce.
Thanks
OK, so what happens if we just let the failed banks fail? Entangling alliances?
Does it trigger a counterparty risk scenario?
Is this how we get to zombies?
If engineers or bricklayers were holding us hostage, and not bankers, would we resist?
"If engineers or bricklayers were holding us hostage, and not bankers, would we resist?"
That question was already answered, in an old movie:
Solo: "That's because droids don't tear people's arms and legs off when they lose."
C3PO: "I suggest a new strategy, R2. Let the wookie win."
What happens if EU banks were to fail? (I don't see this) I think that is easy to answer. Global depression would soon follow.
That is why I think that something is coming. Too much to lose.
Global depression for who?
One must define "depresion" in its actual effects, which include a clear sense of the different effects on different classes/categories of humankind, aka persons...whether idle rich or the butcher-baker-farmer-nurse-repairman-et al.
Do you live in a moated-community? Or rather, how moated/insulated/privileged is it?
When is it okay to violate "Unfairness leads to chaos" principle?
1 BIG ASS EU BANK MERGER and than the Central banks would step in to make it liquid again.
In other words, we is all Japan now !
Japan didn't have a trade deficit.
You assume that the "something" remedy will be efficacious. I agree they will try but I am not sure it will work.
Certainly might happen but most people can't yet see the problem so given the likely unpopularity of such a move I think they have to let the situation get worse before acting. Also doesn't ECB have to fail controlling the situation before FED can interfere? They most be the first point of liquidity for EU banks?
Not in my opinion. Once the fire really starts it will be very hard to put out. The CBers all know this. I think they want to get ahead of the problem before it gets out of hand.
That said, the EU political and financial leaders have fucked this up at every step. They may will screw this one up too. As always, we shall see.
This is dollar printing. The dollars are going to the ECB's, and we maybe getting Euros (printed by ECB) back. Europe needs the dollars as they (the people) are dumping the Euro for USD's. If they don't have enough dollars to meet demand the Euro crashes, and the dollar sores. For the US, it is just more inflation (more dollars out there). China is not going to think much of this too. The US IOU's (US bonds) lose some more of there value. I have to eat, and more inflation is just not good news.
Don't forget that it will be unwinded in the future.
Bruce, the euro leaders only get back to work this week. I have never seen them react to a problem within 1 week. Even if there was a meteo comming down in 2 days, it would take them 2 weeks to get the message out and plan 500 meetings for it.
To me it looks like the Germans have teamed up with the Chinese to fight the inflation created by Bernanke's money printing (explains ECB's interest rate hikes) so I would imagine they are fundamentally against a liquidity injection if we are talking newly printed fiat (I appreciate you don't directly say that but I read between the lines that you speculate that Ben would see this as a printing opportunity?). Are the CB's interests even aligned here beyond obviously wanting to avoid a funding crisis? It could be an opportunity for the Chinese to swap some of their dollar reserves into Euro's (the recent behaviour of EURUSD suggest it might already be happening) and I hear that Bank of Japan recently (after disagreements with FED over its currency interventions) started lending USD reserves out in the over night market in Europe. So not very clear the CB's are united (actually they are all fighting currency wars) but perhaps a crisis will force their hands.
They teamed up to use the real USD holdings not the freshly printed ones. USD`s with real value, backed by manufacturing force, not the printing press. That`s why China spends USD in areas where US companies will never again set foot.
Walking the tightrope...
Teeter, teeter, bitches!
The real fireworks start when all of those people (millions and millions) can't pay for necessities anymore with illuminati toilet paper.
Yeehaaaw, bitches!
Sounds ominous for EU banks, do or die time. But in my humble opinion, the ECB will always bail out the EU banks. Your ratios do not reflect a valid criteria which is applicable to sources OTHER than bond market and inter bank lending for Socgen. The safety net the ECB is prepared to put up for ALL banks in Eurozone will ensure full liquidity to these banks if interbank freezes up.
As these banks will continue to get squeezed, their shares falling to ground zero, in case the sovereign spreads increase down the road, there will be two decisions necessary at Euro level:
1° THe banks will have to take massive haircuts down the line. Sovereign debt has to be reduced massively as economic growth is not possible otherwise. In case the Banks lack capitalisation the national banks will recapitalise them as the US did for Citi etc. in 2008.
2° The ECB will continue to issue "sterilised" money, providing liquidity to troubled banks even if they become more "bad" bank of Eurozone, and their own spreads increase.
Somewhere along the line the Germans will have to decide if they want EU to survive or not. If yes, we will have a 3 trillion euro 'fail safe' mecanism, an international "bad" fund whose governance will have to be decided, and there will have to be fiscal union and Eurobonding down the road to mutualise the cost of sovereign borrowing. This Germany must accept, which means EU will have to have a collective economic vision for the future. That is not the case today. Big mind set change. But the times are ripe for paradigm change down the road.
If not, then Plan B, and we are back to a two tier monetary Union or worse, to individual nation state monies. All this has to occur in the interim period of economic stagflation and financial reset in the cards for 2012-2015 period. (Excluding WW3 scenario).
My bet is that the Germans will go federal. But there will be much pain as selling this politically in the major EU countries, will not be easy. May take time, and the world economy will stay in doldrums on all continents.
Falak, not to diminish your other points at all, what the EU banks need right now are USD. The ECB doesn't have USD, and won't, unless the aforementioned swap line with the Fed is opened up. Among other things you've got millions (billions?) of MMMF funds being repatriated to the U.S.
And yet the euro is fairly strong against the dollar so somebody most be more than happy to take the other side of the trade.
China?
and not only China.
F, you present some valid points, however the clock is ticking and the scenario you outline has one key ingredient, which is time and lots of it; and time we do not have.
Napoleon at Waterloo : If only Grouchy were there; instead of Blucher!...
Time is what man cannot control.
Enter the ECB today : and they will "sterilise" and take on the sovereign loans held by private banks, in exchange of new liquidity. Ad Nauseum...
In principle, the overall debt of Private sector banks in PIGS is 2.5 trillion Euros. The ECB can take this on provided the banks take a haircut and Euro bonds occur down the road.
Wait n see, the games go on!
Hi Bruce,
I'm not an expert on funding and swaps. Can you kindly provide a didactic explanation of Swap Window and when, why a bank uses it? I believe it's because the premium to short term Euro swaps are rising so they turn to central bankers for better rates on the swaps?
thanks
For a nanosecond I thought Cheeky Bastard was back!
;) http://macroblog.typepad.com/macroblog/2008/09/thursdays-post.html
The EU banks NEED DOLLARS. They have as many Euros as they want. But they do not have the dollars they need. That is the stress of that red area in the chart.
Who has lots of dollars? The Fed does. They can electronically create as much as is needed. But the rules say they have to get a reserve currency back in exchange.
If I lend you USD10 and you deposit back Can$ 9.9 Then you would have the US dollars you need. I would have the "security" of your Canadian money to insure I get my money back.
Ever go to a pawn store and hock a watch? That is a swap transaction at work.
Thanks for continually to educate Bruce. Sure would like to get a look at the Feds ledger to see what rules they are actually following. Or, if there are any rules.
Europe has gold. Plenty of it.
Not so much in the UK. Thanks a bunch Gordon...
The learning curve is your responsibility....
Bruce, you do good work, thanks. Measuring the health of the banks is a bit of a mug's game with so many moving parts and underlying assumptions. While simplicity can sometimes be helpful it can also be misleading (not suggesting that). One of the issues is that the banks themselves don't know let alone those looking from the outside in. Suffice to day your measurement serves as a basic red flag like the warning light in your automobile.
As for the big announcement that the market is expecting, I think you are spot on and would bet this Sunday otherwise markets could go nuclear if nothing comes out of Jhole and the political sensitivities.
The real concern is that this is the last bullet in Ben's six shooter and we'll be lucky if its impact lasts until Friday should it be announced tomorrow.
Also the latest from ECRI is not good at all.
Whatever happens will need the cooperation of our benefactors, namely, China . Euroland is China's largest export market followed by Brazil and US. Could explain VP Biden trip to China to seek assistance while Pres. Obama goes on vacation so as not to unsettle markets. Reggie is on same page as Bruce regarding Euro bank meltdown. Looks like Labor Day Holiday may also become a Global Bank Holiday as well. Otherwise we are looking at Halloween which would be more appropriate. Might also make Thanksgiving more meaningful for Bankers.
That fact the market doesn't value any of the above banks at the value of their "assets" says a lot about the quality of those assets.
<p>What is Indian IT telling of EU and US economy?</p><p>Armageddon!!!</p>
Capital3x
The vertically structured sweat act that is the fiat-based financial system is collapsing before our eyes. Hallelujah and good riddance.
BK
You make a credible argument that Bernanke & the global syndicate likely need to do something to save the "system", and what that something might be.
But not many of us are keen on bailing out the financial tycoons in any manner, shape, or form.
Might you turn your critical eye toward what needs be done to REPLACE this most unfair and inequitable system rather than to save it?
There's not going to be a top-down solution to this crisis. It's going to be a grassroots re-organization starting locally. The way to work towards replacing the system is to remove yourself from it as much as possible. Don't let them profit from you if you can help it. Try to buy and sell local, and don't keep your money in anything they touch, especially Federal Reserve Notes.
rwe it will take a crisis for a new system to emerge and believe me the process will include suffering that heretofore has been unimaginable. When Faber hints that being in a city will be a bad thing he is not alarmist if the banking system goes down the past 24 months will seem like Leon Black's birthday party. We are on the precipice and about to lose our grip.
http://www.youtube.com/watch?v=SjZrVw9gnUg
If there is a way to unwind the current system with the least amount of suffering,
than the elite are even more at fault if they do not take that route and choose instead to prolong their privilege.
I strongly suspect (no, I'm completely certain) that the elite will prove once again that the sans culottes should bring back the guillotine as the punishment of choice for sociopaths.
rwe, perhaps your point of view might be unsullied by the harsh reality that there is no interest (pardon the pun) in a smooth unwind. It's not what bankers OR politicians do. They simply wer steel toed boots and kick cans and balls as hard as they can, as often as they can.
Opportunities galore to do the "right' thing have come and gone. What BK is suggesting (implying) is further evidence of that. We are weeks if not days away from Mayhem. Weeks if the kick works, days if it doesn't or is not meant to.
These swap lines are also above board and transparent to the extent that no national (or is that notional) security is threatened. I imagine the bankers have a few more tricks up their book-sleeves, that will allow Virtual QE.
It looks like a QE, smells like Burnign arse, feels terrible to be around, but cannot be pinned as a donkey's last hurrah, if you get my hashed metaphors.
Vivek (ORI)
http://aadivaahan.wordpress.com
The way I read BK is taking a guess on what he believes will be done and the thinking behind the decision, not necessarily advocating the action?