All For One, And One For All...
Via Peter Tchir of TF Market Advisors
Ignoring the knee-jerk reaction of stocks to rally 4% on the headlines that Dexia will be save and other banks will be recapitalized, it is worth thinking about what this really means and the next logical steps.
For now I will not even focus on the fact that this was from a meeting of Finance Ministers and not heads of state. I left my "EU Leadership" trading cards at the office, but so far, not many of the big names, who can actually close the deal, have spoken. I won't even focus on the fact that Dexia has been on the fringe of "contagion" discussion. Look at articles about "contagion" or "debt crisis" and PIIGS and French Banks and German Banks and Italian Banks show up in nearly every article. Dexia is discussed less frequently, though ZeroHedge has been on top of it for awhile. So stocks rose 4% on a plan of a plan to plan a plan for a bank they hadn't heard of until this morning. Hmmm.
Dexia had 566 Billion Eur of assets at the end of the year. It currently has a 2 Billion Eur market cap. How many of these assets are "bad" assets? Someone is going to have to lend against those bad assets. Sounds like France and Belgium are up for the job. Belgium has Debt of 322 Billion Eur and GDP of 340 Billion Eur. How much of the bad debt can Belgium realistically finance? How many assets will the "good" bank have? How much equity capital will it need? What are the "good" assets? The bad assets are sovereign loans, residential real estate loans, commercial real estate loans? Are the good assets just bonds of other banks? Dexia is not small, and both the "good" bank and "bad" bank are likely to be sizable entities.
Will the assets be transferred at market prices? Is there a chance the market will be horrified when they realize how big the unmarked losses are? If they aren't transferred at market, how can the countries that are providing the financing justify that to their citizens? This may shine a lot on just how bad the bank's books are and that may trigger the contagion everyone bending over backwards to avoid. Who will want to invest equity in the "good" bank? The management that got the bank into this situation will still be there, so it is unlikely to attract private investors in size. If we learned anything during our own crisis, it was that "good" assets tend to become "bad" assets a quarter or two down the road as the economy struggles. Think back to the first time the US proposed MLEC (some form of bad bank). Half of what was considered good at the time, is what dragged Bear and AIG down.
More importantly, where does this leave France? France is going to have to bear the brunt of the burden. Belgium is just too small to save Dexia. France is big enough, but will the rating agencies just sit around and wait for France to destroy their sovereign wealth by propping up banks? BNP has a 33 Billion Eur market cap, with assets of almost 2 TRILLION Eur. I'm guessing some of those assets are loans to Dexia or why would the French government be so eager to get involved?
How much equity would "recapitalize" someone like BNP? Can the bad assets be shifted to the French government? Can the share price survive a 50% dilution if that is what was required? The governments can recapitalize, but how much capital is necessary and how much will it dilute existing shareholders? How much equity investment can the French government support? I guess they can support a lot, but I remain convinced that the rating agencies are getting nervous leaving them with an unblemished AAA rating. They are being so cavalier with sovereign money to protect private money, that something has to give.
But France isn't even the biggest concern. What about the Italian Banks? Who will help them? Italy? Then who will help Italy? They just got downgraded by Moody's - a 3 notch downgrade and left on watch. That is about as bad as a downgrade gets. Italy, already with debt to GDP above 100%, already on the hook for about 85 Billion Eur of EFSF money is going to have to recapitalize its own banks and take on their bad debt? Intesa with 18 Billion Eur market cap and 659 Billion Eur of assets is not a small problem for Italy. If each country is going to back its own banks, won't that just drag down the weakest countries? If France and Germany come to the rescue, won't that just drag them down?
This is becoming a national problem. Each country will have to deal with it as best as can be. If there was already bail-out fatigue regarding sovereigns, how many citizens will want to bail-out banks in other countries?
If no bank in Europe will ever default or having any risk, then it makes sense for MS in particular to rebound, to the extent it was only down on concerns about exposure to European banks. But how long will that last before people get concerned that the countries cannot afford the bailouts?
I think the markets will be horribly disappointed with this announcement in the end. It will turn out difficult to implement in any case, and will not be enough to stem the fears of contagion. It will use up enough funds that there will be growing concern of the sovereign crisis spreading, and fears that money that was meant to be spent buying PIIGS bonds in the secondary market is going into equity investments in banks. Too much money was lent too poorly. There is not enough money to fix it. They have to print money or let some real losses be realized. Tomorrow could be fun again, but I think this euphoric rise in the markets will be short lived again.