Lest We Forget
Via Mark J. Grant, author of Out of the Box,
The above data is directly from the ECB. The data is current as of last Friday, September 28, 2012. I invite you to do your own analysis. I will give you mine but do your own so that you have a very clear picture of what is happening.
The first thing that might strike your attention is the assets and liabilities. The consolidated balance sheet shows a figure of about 3,240 billion Euros ($4,000 billion) and yet we find assets of 16,303.9 billion Euros ($21,032 billion) and liabilities of 17,334.1 billion Euros ($22,361 billion). You may wonder how this is possible given that it is impossible using American accounting principles and the answer is that the ECB does not count government guaranteed debt as either assets or liabilities when compiling their consolidated statement. This would include sovereign debt, bank debt guaranteed by a sovereign or any securitizations, derivatives or corporate debt where the sovereign guarantees the credits. However if I apply American standards then the balance sheet of the European Central Bank is $22,361 billion. This would be as compared to the Fed with a balance sheet of about $2,300 billion so that the ECB has a balance sheet ten times the size of the Fed.
“Recognition of assets and liabilities - An asset or liability is only recognized in the Balance Sheet when it is probable that any associated future economic benefit will flow to or from the ECB, substantially all of the associated risks and rewards have been transferred to the ECB, and the cost or value of the asset or the amount of the obligation can be measured reliably.”
-The European Central Bank
You may also note the loss for the last quarter; 1,040.2 billion Euros or $1,341.8 billion. As a matter of calculation, utilizing the last three quarters of data, the annualized loss for the ECB is 4,187 billion Euros or $5,401.2 billion through Quarter I of this year which is the most up-to-date figures available. Now the ECB only has about $18 billion of paid-in capital by the national central banks of Europe so you might consider the leverage at work here both for the assets and liabilities and for the losses incurred.
“Central bank capital still does not seem to matter for monetary policy implementation, in essence because negative levels of capital do not represent any threat to the central bank being able to pay for whatever costs it has. Although losses may easily accumulate over a long period of time and lead to a huge negative capital, no reason emerges why this could affect the central bank’s ability to control interest rates.”
-The European Central Bank
The view of the ECB raises some interesting questions. I believe most would agree on two issues; first that the ECB is an insolvent institution and so highly leveraged and under-capitalized that a normal bank would have been in bankruptcy long ago but then a normal bank can’t print money. However it must also be said that the ECB is not a stand-alone institution living on another world and that the national central banks of Europe own it. Second I think most thoughtful people would agree that at some point in time that the financial condition of a central bank matters either in terms of increasing inflation by increasing the money supply or as a matter of valuation if no one or not enough financial institutions will support their currency or if some national central bank opts out on the basis of the economic threat to its citizens. This could be exemplified by Germany. Twenty-two percent (22%) of the obligations of the ECB are liabilities of Germany. This means that Germany ultimately is on the hook for $4,978.2 billion of the liabilities at the ECB which is about $1,500 billion more than their GDP.
The ECB’s balance sheet also indicates a $295 billion loss for Germany as their percentage of the entire loss taken in the last quarter or $1,188.3 billion for the annualized loss. This, of course, can be applied to France and the rest of the countries in Europe and it is certainly possible that at some point some central banker, some politician, some national government will look at all of this and decide that enough is enough. It is also possible that the ratings agencies will decide to include the liabilities of each European country at the ECB and add them to their sovereign obligations which would rate Germany probably at a “CCC” and the rest of Europe somewhere blow that. As to the three major ratings agencies, the same ones that rated CDO’s “AAA” on the basis of diversification, I wonder if in accepting Europe’s fallacious debt to GDP ratios data, their non-inclusion of each nation’s liabilities at the European Union and then the same for the ECB, if we are not being lead down the garden path once again to where the road narrows and the thorns tear at our skin.
Aside from all of that I feel compelled to ask the central questions that should have been asked prior to the American Financial Crisis. We all had the data, we all saw the sub-prime mess, we all saw the leverage, we all saw the money handed out for nothing and the non-disclosure documents, we all saw the lack of credible ratings supplied by the ratings agencies and yet we went on like it would all continue forever. We ignored it all. We turned our backs but then; we got scalped and so the prime questions must be asked:
Are we wise men or are we fools?
Did we learning anything from the last go round?
Should we act now before we are scalped again considering we only have one head?
“Logical consequences are the scarecrows of fools and the beacons of wise men.”
Then I would turn your attention to the derivatives owned by the ECB. We are given a net number. There are no gross figures included. We have no way of knowing how much leverage the ECB has on its plate or whether the shorts are accurate off-sets against the longs. One more piece of data to consider! Then look at the investment portfolio of the ECB. Assets of 5,034.7 billion Euros ($6,494.7 billion) and liabilities of 7,833.9 Euros ($10,105.7 billion); a 36% deficit.
Finally after all of the screaming and shouting of having Greece maintain a 120% debt to GDP ratio, a miserable failure in both projection and policy, what do we find at the European Central Bank? It is right there in black and white and it is for all of the countries in Europe not just those that utilize the Euro or it would be much higher; a debt to GDP ratio of 183.3%.
I began this piece at 3:00 A.M. on Sunday. It occupied my entire day. It will be read by most of you in just a few minutes and disposed of as you go on to other activities. It will be dismissed; perhaps not out of hand but dismissed none-the-less as perhaps an interesting note but one not applicable to our current circumstances. Yet I wonder if it would not be wise to give my musings more thought as I fear that the tea is brewing and the hot water may boil over and I point to just how this could happen.
As the Fed and the ECB create massive liquidity it is apparent that not only can they not fund off-planet but that we cannot invest off-planet either. Consequently capital is created, injected into the system and invested in earthly ventures. There are some that may think this is a state of perpetuity, that it will go on forever and that liquidity to cure solvency is a never-ending time line like the stars in the heavens. Uncountable, unknowable and within the purview of a higher being. However prudence demands that thought be given to how it could end and what it would mean and what should be done in case the bough breaks.
The game could end if a major European bank falters; the inter-locking schematic of European sovereign and bank debt and the political realities of a Europe where governmental “suggestions” cannot be denied would pull severely upon the construct. You may wish to note Credit Agricole in France or Deutsche Bank in Germany where leverage is around 70 times their capital. Then if any country, including Greece, actually decided to depart from the Euro, regardless of the pandering offered by the EU, the devastation would be quite real. There could be social unrest in Greece, Spain or Portugal with the outlier being France and this would cause great consternation. Great Britain could decide to actually have a referendum and then vote to leave the EU and this would be another major blow. With the Netherlands and Finland already having publically said “No” to using any more of their money for Greece or any other country there could be such a division between the haves and the have-nots that a core funding country decides to exit. We have already seen a rise in Nationalism and we could see a new set of politicians in Germany, Austria, Finland et al where the hue and cry is that country for their own citizens so that the deepening recession on the Continent changes the politics towards more insular regimes. None of the above, in my opinion, are so far afield that they should not be considered and all of these possibilities could be “game changers” for the Continent.
Besides the banking system and the political system keep your eye on gold and other core commodities. If there is a rush into these assets and out of stocks and bonds then you will get a hint that people are losing faith in the entire system. Also watch U.S. Treasuries as the safest of havens in an uncertain world because if prices begin to spike again it will suggest an increase in the “Fear Factor.” The recent revolt in Catalonia is also something to watch as any move towards succession will not only damage Spain but all of Europe in its severity as the wealthiest region in the country leaving the nation and could even spark some kind of civil war. Italy may also come into the spotlight and even France as their socialist government wallows in its own political jargon.
Since the American Financial Crisis the world has lived off the largesse of the major central banks. It has been a slippery slope and each capital injection or “save the world” speech has been met by risk-on and higher markets as liquidity floods the system. It is a judgment call on my part but I think we are about done with the effectiveness of moves by the central banks. At close to zero short terms rates and the effects of the Quantitative Easings wearing off I do not think that the Fed has much more than it can do that will be helpful. After promises of “unlimited” from both the Fed and the ECB have infatuated the marketplaces and died away; I ask what else could be promised past what they have already laid upon the table. “Not much” is my honest conclusion and so the “Greatest Magic Show on Earth” may be over and the cat is now out of the bag. Recession in Europe that is worsening, a major downdraft in China, Japan and Korea, the end of the great spectacle of the Central Banks and I think a recession in America is on a very near-term horizon.
I apologize for alarming you on this Monday morning. It was in March 2008 that I began to warn amount the American Financial Crisis. You may say what you like but the call was correct. We have shimmied and slithered since then mostly due to the liquidity provided by the world’s Central Banks but there are limits; there are always limits. I can smell the breath of the Beast once more and I can hear him breathing just behind my back. I began today’s piece with a factual accounting of the ECB and the state of its financial condition. I remind you of the American Financial Crisis and what caused it. I take time today to intone the words of the Prophets once more:
“Lest we forget; lest we forget.”
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