Mere hours after the annual European Eurovision song contest ended at a cost to the host country in the hundreds of millions, money which should have been spent productively elsewhere but wasn't while providing utterly unnecessary distraction to hundreds of millions from what is truly important, we get another stark reminder that the continent is not only broke, but that it no longer even pretends to have credible ideas about how to go about fixing itself. The latest speculation: "Secret plans are being drawn up in Brussels for a European rescue fund that could seize control of struggling banks across the Continent. The scheme, which would be funded by a levy on banks, will be presented by supporters as a "silver bullet" that could halt the steady escalation of the eurozone debt crisis. It is being worked on in tandem with a proposal from Mario Monti, the Italian prime minister, for a Europe-wide guarantee on bank deposits. The proposal would throw the financial muscle of Europe's stronger nations, and healthy financial institutions, behind weaker countries and lenders. Proponents, including top advisers to the European Commission, say the removal of the threat of bank collapses would restore market confidence in Italy and Spain." In other words, last week's rumor that was supposed to be presented at the latest flop of a FinMin summit is once again being reincarnated as apparently nothing else in the European arsenal has any remaining credibility - and as a reminder, none other than unelected Monti's one-time employer Goldman Sachs said a eurowide deposit guarantee would not work.
"The bank scheme would see all eurozone lenders forced to pay an annual levy to a deposit guarantee scheme set up as a separate company. The company would be back-stopped with cash from the European Union, the European Central Bank or the new European Stability Mechanism."
Bottom line: the "silver bullet" plan is "secret? because it is a total farce, and nobody could possibly present it with a straight face for one simple reason - there is no source of money. No hold on, there is - Germany. And as Merkel made it very clear, Germany will not fund it. Why? Because once it starts, it won't end.
Why won't it end?
Instead of regurgitating what we have already explained countless times, here is a CTRL-C, CTRL-V of our article from a month ago, which explains that since the total undercapitalization of European banks is as much as €2.9 trillion, there is not one entity that can possibly backstop the entire towering edifice, which is the only possible thing that could restore confidence in Europe's financial system. Simply said: banks can not raise levies to prop up their peers, as they have to raise capital to support themselves! And anyone suggesting otherwise, is merely pandering for populist brownie points, and hoping their electorate is dumb enough to fail even elementary math. Our only question is how long will Merkel tolerate Monti's increasinly louder demands that Germany bail out Europe's insolvent states, such as Italy... and just how truly deep is the Italian "hole"?
From Zero Hedge, April 29, “A Trillion Here, A Trillion There...” – Why 90% Of The European Bank Sector’s Market Cap Is Vaporware*
Two weeks ago the BIS released the Basel Quantitative Impact Survey, "Results of the Basel, III monitoring exercise as of June 2011" which contained several very scary numbers that were noted in Zero Hedge yet which barely received any mention in the broader press. Because the numbers were all very, very large (think eyes glazing over 11-12 digits large), and because their existence meant that the long-term, chronic pain for Europe, which is and has been one of public (and selected private) sector deleveraging (which oddly enough is called “austerity” by everyone to no doubt habituate people to associate debt reduction with pain - where is "mean-reversionism" when you need it?), they, and the BIS report, were promptly buried under the dense foliage of the signal-to-noise forest. Yet it is numbers such as these, that provide us with the best possible glance at the entire forest, no matter how much the various global financial authorities enjoy inundating the hapless speculator crowd with endless irrelevant “trees” on a daily basis.
The numbers referred to are the BIS-suggested bank solvency deficiency to reach a viable capital level (not liquidity) explained as follows by UBS:
The QIS states that the June 2011 shortfall of common equity to a 7% common equity tier 1 ratio for major banks globally was €486 billion. We can estimate from this that the shortfall to a 10% common equity tier 1 is €1.02 trillion. Some years hence and before the mitigation that banks will undertake aggressively, but nevertheless, a trillion is a striking number.
UBS is perfectly happy to "go there":
A trillion here, a trillion there...
The QIS then goes on. The shortfall to the Liquidity Coverage Ratio is €1.8 trillion and 40% of banks have a LCR below 75%. And the shortfall to the Net Stable Funding Ratio is €2.9 trillion. A third of large banks would not meet the 3% tier one leverage ratio. These are gigantic figures relative to the size of the real economy.
Total bank debt issuance globally in the last 12 months was €1.1 trillion. That is, the shortfall in the Net Stable Funding Ratio is almost three year’s worth of issuance capacity.
In other words we not only finally have a problem quantified in terms of scale, but the scale happens to be very, very big:
These figures compare with global GDP of US$59 trillion (€45 trillion). In other words, the NSFR shortfall is equivalent to over 6% of global GDP. We would not regard this as insignificant.
One can just feel the smirk on the author's face as they added that last bit...
But forget global GDP - a number goosed by debt creation itself, and thus one which benefits from leverage, the very process the BIS is warning against. Far more disturbing is this number when juxtaposed in the context of the European financial segment, also the inspiration for our title:
For Europe specifically, a related EBA publication15 implies a €511 billion equity shortfall to a 10% common equity tier 1 ratio. This is 90% of the €565 billion in free float market capitalisation of the European bank sector. The Basel III leverage ratio of large banks as of June 2011 would have been a measly 2.7%; the LCR just 71%, representing a shortfall of €1.2 trillion; the NSFR shortfall is €1.9 trillion. Total European bank debt issuance over the last 12 months has been less than €600 billion.
In simple terms, virtually the entire equity buffer of the European financial system, or 90% to be exact, would be wiped out if instead of focusing on maxing out risk returns by unsustainable leverage, Europe’s banks were to actually seek to transform into viable, stable entities, in the process marking their massively mismarked asset base to market. Something tells us that the equity tranche in Europe, and elsewhere, would be rather averse this dramatic writedown in valuation merely for the sake of avoiding future taxpayer bailouts. After all that’s what naïve, stupid, $0.99 cent iApp-fascinated taxpayers are there for: to be abused.
In other words, thanks BIS but your math is not welcome here. The can will promptly be kicked down the road or else.
Yet what is most troubling is that there appear to be no way out for European banks, in other words not even the status quo’s favorite pastime – can kicking – is very sustainable at this point:
Returns on banking are now quite inadequate to attract significant fresh equity into the sector. The regulatory agenda means that there is likely to be little confidence in this changing over the next several years. Banks must therefore turn to the state for their incremental capital or seek to shrink their profile into the amount of stable funding and equity they presently have. Deleveraging is alive and well and living in the euro area.
And just a tangent, the BIS data and analysis was of June 30. That's before all the fun in Europe really started.
Needless to say, raising $2+ trillion in new capital over the next 5 years will be next to impossible as European banks are hardly what one would call profitable (implying retained earnings as a source of capital is nothing but a cruel joke; now as for retained losses...), and as we saw when UniCredit tried to raise some equity in the open market only to see its stock get annihilated in January, pitching capital raises through equity issuance to Euro fins is the surest way for any investment banker to get sacked.
Which means one thing: as markets get progressively smarter (yes, it will take a while) that there is a difference between capital and liquidity, and demand it from banks that otherwise risk a Lehman-like fate, the asset dispositions, i.e., sales of the blue-light special variety, are about to kick into high gear. Here, while for every buyer there may be a seller, when faced with a known onslaught of about $2.9 trillion in asset sales over a period of time, one thing is certain: it will be a mecca of a buyer’s market as liquidations become wholesale and prices across most asset classes tumble as a result.
And as noted in the post just prior, courtesy of Europe’s Dead Bank Walking list, the market will know just where to go first (and second, and third, etc) for the biggest liquidation deals once the “For Sale” signs are posted.
* Vaporware in a Jon Corzine sense, circa November-December 2011; not in the context of Duke Nukem