Europe: "The Flaw"

Tyler Durden's picture

We have posted various extracts from this piece from Credit Suisse previously. We will post from it again, because, to loosely paraphrase Lewis Black, it bears reposting... especially in the context of the latest and greatest Greek "bailout" (of Europe's bankers), which incidentally, will achieve nothing and merely bring the country one step closer to a military coup and/or civil war.

The flaw

The market is essentially proceeding on the assumption, as we see it, that banks’ capital requirements can be met organically, through earnings and deleveraging. We want to be very careful about leaning too hard on this; we have insisted for a long time that the banking system needs to shrink, and that the capital markets would grow to match. But this is not a short-term process and cannot be, if it is to remain orderly.

 The 2011 consensus range of bank capital requirements was € 100bn to €400bn; the log. average, €200bn, always seemed like a sensible estimate to us. The market is proceeding on the assumption that the need has all but gone away; many estimates now centre on €50bn. Such numbers strike us as ridiculous; the Greek banks alone are absorbing that (see above) and Anglo-Irish absorbed €30bn. This is (yet) another of those cases where a number is small until it is needed, at which point it grows.

But the market has made these moves in thinking despite our long asserting the premise that liquidity cannot cure a solvency issue, and it is liquidity that has been the big change.

What’s happened?

Partly, “the paradox of thrift”. Each bank individually can credibly plan to delever, but collectively the system cannot. But even if the inherent contradiction is recognised, it is hard to act on immediately.

Debt is no cure for debt. What it can do is prevent a self-fuelling Fisher-style debt-deflation and it is clear that the LTRO has at least to some extent achieved that. And it can buy time such that, if the basic business model is restored, solvency can be earned. But we are not sure the business model has been restored; far from it. Here again, our caution and outright mistrust needs to be tempered, and at least patient. But the apparent widespread notion that the LTRO is a game-changer simply does not wash in our view, because of our premise. Game-saver (no Fisher); yes. Game-extender, which makes it a potential gamechanger [Let’s torture a football analogy. If you are down at full time, injury time at least give you a chance, but cannot guarantee a win, unless for a potentially infinite period of your choice. Not every game can be France England 13 June 2004; 0-1 at full time, 2-1 after injury time as Zinedane Zidane proved that football is a game of two halves and two minutes. But every game has an exante chance to do this; even Germany-England, 1 September 2001, which is the rough equivalent of the situation facing the European banking system, in our view; 5-1 at full time with approximately four minutes added.]; yes. Outright game-changer; no.

So what’s the flaw?

The flaw is that, even in 2012, we retain respect for markets. Unfettered, they are not the tool of choice for resolving the current situation but we see it as essential to work with them and harness their power, rather than against them, as we discussed in Twelve  Steps.

In Greece it is now clear that the process of avoiding a credit event for the past 21 months has been ruinously expensive. Frustrate the markets (again, individuals making rational, fiduciary decisions, not some conspiracy pursuing an agenda) and they will find a way around the frustration, in our view; in the meantime, costs will increase due to the inefficiencies created, as has happened in Greece.

The result that we now expect in the European banking system is in our view rather beautiful.

The Basel Accords have a patchy track record – to put it at its most generous – and the EBA has almost no track record at all and as we see it, even less credibility in the eyes of the market. The market is fickle (and in this situation self-fuelling, so it must be tempered; indeed it has been by the LTRO), so it cannot even trust its own estimates (as stated above, they are all over the map). But it cannot be frustrated in seeking comfort on such an important issue as restoring trust in the biggest banking system in the world, in our view.

In the banking system just as in Greece, the rescue funds are coming in at a senior level. There are therefore two kinds of bank; those with the market’s full confidence, which will be able to fund at a “senior” but partially subordinated level, and which can repay everything without question [Or, are seen as being able to even at sub level. Either they take advantage of the very attractive ECB funding on offer or issue covered bonds, for example, with no risk or entering the self-fuelling subordination loop.] and those who cannot. The price of time to the latter is ever-further subordination in a  self-fuelling circle. Over time, the market will empirically, and with efficient pricing, weigh the liability side of the balance sheet versus the asset side, less haircuts (so haircuts become the de-facto capital requirement), tranche by tranche, maturity by maturity, and see what happens. If there is any insolvency in the European banking system, it will eventually appear, independent of Basel or EBA requirements (which may still becoming binding, of course). But it is hard to see how it appears before some time has elapsed. In this environment, competition for retail deposits, of which the European banking system is chronically short, largely because of its size, will become ever more intense.

Inevitably, due to the mark-to-market nature of repo, the banking system is now even more sensitive to mark-to-market, further baking volatility into the cake. This reinforces our idea that the ultimate arbiter of bank capitalization is the senior unsecured market.

We suspect that organic earnings retention cannot be the solution. According to ECB data, the aggregate post-tax profits of the banks of all EU27 countries were €46.8bn in H1 2011, more than 100% accounted for by large banks (medium-sized banks lost $1.8bn). This pattern has been persistent since the unusual 2008 year (see Exhibit 2).

It is impossible to extract trends from this table, but it clearly does not invalidate a hypothesis that weaker banks (where by definition capital needs are concentrated) might take a long time to earn the requisite capital. Even if capital needs were heterogeneously distributed, which they are not, a period of weak profitability and capital needs at the upper end of the spectrum would suggest a long period. And during that period, we salami-slice balance sheets. Watch your fingers.

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HedgeAccordingly's picture

inflate it away.. bonds still pricing worry -

Mr Lennon Hendrix's picture

What isn't pricing worry.  Gold at all time (nominal) highs (good enough to trick people into thinking it is in a bubble) silver testing its nominal high just a short year ago, oil back at highs but on limited US demand, mass curruption at city, county, state, and federal levels, the human race more concerned with dying hollywood stars than they are with the real heavens and more interested in faux presidential races instead of understanding the Dialectic they have been boxed into.

Even those who are not ignorant shhrug off the fact the the word fiat by definition means "not real".  We will pretend our way into the future and let bygones be bygones!  Who needs history! 

What's on the tube?

Mr Lennon Hendrix's picture

Or SHLD.  Should we buy SLHD?  It's a recovery afterall!

I am surprised that one of our faux trolls haven't caught on that bulls are touting a recovery beyond imagine.  You would think Robo or Hamy would be writing such.  I guess even the trolls aren't as stupid as Liz Ann Sonders.

JW n FL's picture



Off TOPIC! FYI for the Family.


So far this year, at least 180 drugs that are crucial for treating childhood leukemia, breast and colon cancer, infections and other diseases have been declared in short supply — a record number.


How much money will Wall Street save if they can rid America of these Genetically Inferior or Genetically Defective Children?

If they are not cured? They don’t grow up and have children and spread the disease. And long term, Exponential Growth of the Genetically Defective.. that would need to be treated.. in inflated dollars! Instead of a straight drop down profit!




You think that there could Never be a concerted effort against We the People.. to that scope and scale? LOL!! FOOL(s)!!!


180 Drugs to keep alive.. Genetically Defective People who would then Procreate! To spread these expensive diseases too!


NOOOOOOOOOOOOOOOOOOOOOOO! That would never happen! Just like the We the People would NEVER! Pay Wall Street to keep us enslaved in debt.. and then pay them the interest.. to keep us that much more enslaved!! We the People are FARRRRRRRRRRRRRRRRRR! To aware of what’s going on to allow anything like these things to happen!


Bill gates promotes population control on CNN

and for all of you that said he slipped that one time he said Population Control @ TED! Are Fucking Stupid! Not Ignorant!!

Only the Genetically Weak or defective will die from the Vaccines’! LOL!!

Bill Gates EXPOSED Progressive?! Wants Population Control Through Vaccines "something I love"


here is the obligatory Rockefeller clip.


but far more important.. here is the MAN! Telling you why.. and the math that you can back check yourself.. You can repeat the outcome with very simple numbers that NO ONE CAN REASONABLY doubt.

Dr Albert Barlett Clip on The Exponential Function


you sheep should kill each other.. and “We the Rich and Ubber Entitled Lucky Sperm Club Blue Bloods” can come in and strip you of your gun rights.. because all you do is kill each other..

it would be for your own protection!

And then rule you.. peacefully and profitably.. as possible!

“We the Rich and Ubber Entitled Lucky Sperm Club Blue Bloods” of course reserve the right to kill you off.. I mean allow you to kill each other off and then save you again from yourselves.. the whole time being the hero’s that we have programmed you to need!


Please stay tuned to the heavy rotation of ugly facts and how it was ALL the Jews Fault! As the will be the catalyst!

Once again, “We the Rich and Ubber Entitled Lucky Sperm Club Blue Bloods” could Not! do it without your consistent ignorance!


Now get out there and Kill each other!


Harlequin001's picture

This seems like an awfully long winded way of saying that the flaw in Europes plan is that the banks are insolvent. Like we didn't know that.

I'm sure it's come as a revelation to many that smaller banks will have more difficulty in 'earning' their way back to solvency than bigger banks that have access to taxpayer cash.

Whoopy shit, I feel enlightened already, or did I miss something...

boogerbently's picture

So, they need to do what we do here. Give the banks ZERO interest dollars (theoretically to keep the system liquid).

The banks buy govt. bonds with interest.

 The banks make that money, the govt. gets it's debt bought.....badda bing, badda boom, everybodys happy.....well, at least, everyone that counts.

Uchtdorf's picture

I'm sorta counting on Turkey moving in some troops, just to maintain order, of course.

LongBallsShortBrains's picture

Off topic

That's what I was going to say.

Spastica Rex's picture

But Whiteny Houston just died. Show some respect.


UP Forester's picture

Really?  Was it Bobby B or the cocaine that got her?

LetThemEatRand's picture

And to think Keith Richards chronologically could have been her father.   Party on Whitney.  Party on Warren.


Hulk's picture

SHe really did take the big dirt nap. Looks like drugs and alcohol, what a waste...

Treason Season's picture

Those that can get pass mouthing tabloid headlines should read the following. Scroll down about half way and read about Houston's programming.

entropos's picture


Spastica Rex's picture

Great picture of her. I will always remember her when she had straight blonde hair and she and Bobby were still in love. I bet Bobby is taking it hard.


max2205's picture

3 rd year on the Fed bull market going for 4.... Higher highs and lower lows

Get over it. Next leg up will be awesome but be nimble

Eireann go Brach's picture

What a pile of gibberish this was! The football analogies are terrible too, anything to do with the French deserves to be beaten with a stick!

Hulk's picture

OK, here's the fucking deal: I'll give anyone, who can place me in suspended animation and then wake me the fuck up when this shit is said and done,one million post apocaliptic bucks...

This shit is like watching "lost" or having a lifetime of sex with no orgasm ...

damage's picture

I'll pay two million!

francis_sawyer's picture
Europe: "The Flaw" = The Eurozone is a NWO test tube baby & it's not working... THAT's the flaw... Good night & God bless...
Cheesy Bastard's picture

having a lifetime of sex with no orgasm ...  In the future you will wake up in that is not an issue:  2 min video.

Hulk's picture

I appreciate you bringing my nightmares into semi reality...

Cheesy Bastard's picture

Heh!  Just think of sex with no orgasm like running on the treadmill.  You don't get anywhere but it's still cardio...

Manthong's picture

"I think we should have had sex, but there weren't enough people"

I hate when that happens.

Hulk's picture

Thats why I rototill my garden with a shovel (after burning it off) I get a workout with something to show...

withnmeans's picture

Tyler, here is something I found on ekathimerini comments, although I can vouch for all the data. Its a good read from a Greek citizen perspective.

fonzannoon's picture

"The result that we now expect in the European banking system is in our view rather beautiful."


CatoTheElder's picture

It is indeed a lot like "Lost". Shit keeps getting wierder and wierder, and we're finally going to learn that all the characters are, in fact, dead.  I suppose, however, a cross between "Lost" and a zombie flick would be closer to the mark.

Mr Lennon Hendrix's picture

Is that how LOST ended?  They were dead the whole time!  Shit....

Hulk's picture

Thats why they never had no orgasms. Dead folks don't have orgasms...

donsluck's picture

Unfortunatly, Lost being a bunch of people in purgatory is like a dream episode in a series. Totally worthless and manipulative, Here viewers are trying to figure it all out and it turns out, after YEARS, there really is NO STORY! But, TV is a waste of time anyways.

Gunga's picture

.There's a time when the operation of the machine becomes so odious—makes you so sick at heart—that you can't take part. You can't even passively take part. And you've got to put your bodies upon the gears and upon the wheels, upon the levers, upon all the apparatus, and you've got to make it stop. And you've got to indicate to the people who run it, to the people who own it, that unless you're free, the machine will be prevented from working at all."

tom a taxpayer's picture

How gentlemanly to think this is a matter of bankers just needing some advice or more regulation on capital requirements and other prudent banking practices. Not a thought to the possibility that moral hazard, fraud, and criminality are rampant in the banking system. And that maybe, just maybe, we need balls-to-the-walls prosecutions of the bankstas and their aiders and abettors in government.