Submitted by Mark J. Grant, Author of Out of the Box,
“To understand Europe, you have to be a genius - or French. [18]”
-Madeleine Albright
Since I am neither of the above attributes my showing must be impartially considered but I shall endeavor to do my best. Having presented, in previous commentaries, a more accurate assessment of European economies which included derivatives, contingent liabilities, state guaranteed bonds, bank guaranteed bonds and each nation’s liabilities for the European Union and the European Central Bank I shall now offer a few opinions. The data that I presented was not a matter of viewpoint but just an addition of what Eurostat does not count to publish their debt to GDP ratios and so I presented the rest of the story for everyone’s consideration.
Several European institutions have objected to my methodology on the basis that contingent liabilities are just that; contingent. When I pointed out the monoline bond insurance companies and their debacle I was met with polite suggestions that the European institutions know how to manage their affairs better than that. Perhaps so; but perhaps not and these liabilities are there waiting in the wings in any event. Once identified, which I have, then it is a matter of speculation whether these unpleasant character actors may be brought out on center stage to play their roles so I think that it is important to take a rational approach and try to identify which of these may show up during the balance of 2012.
“In a world of paint by numbers you should make sure that you understand the math before you apply your paintbrush.”
-The Wizard
The largest number of characters entering from the wings is likely to be for Dexia bank and their derivatives and liabilities that will go from contingent to “present and accounted for.” I expect this to hit both Belgium and France with some noticeable magnitude. Given the size of the economy in Belgium and the risks that the sovereign has assumed I think we may find their fiscal condition on par with Spain and Italy before the year has ended. Counting up all of their obligations has put the debt to GDP ratio at 203% and I think there will be some sizeable hits for Belgium before the year has ended. I would be quite careful with owning the credit of either the sovereign or of their banks.
Spain would be number two on the hit list. They have massive problems with their regional debt, their banks’ debt and the amount the country has guaranteed for any number of projects. The country is talking about such a severe restructuring and such a large amount of austerity measures that it will drive their economy past the breaking point and their banks, including the largest ones, are actually underwater now in my opinion and just being carried along by the recent LTRO and the decision by the ECB to accept credit collateral that is equivalent to the sub-prime mortgages that were carried on the books of so many American banks. It is possible that the ECB will continue the monetary shower but short of that they will have to come to the stabilizations funds shortly and be added to the list of European beggars. You see, they are caught, if they do not implement what they have promised then the till at the ECB gets closed and if they do implement then the ensuing economic contraction will cause the same conclusion so one way or another, left or right, the end of the road is about the same. There is talk this morning that the ESM may be used to directly fund the European banks but Germany, Austria, Finland and the Netherlands have all said, “Nein” so that this may be the dream of the periphery countries and the nightmare of those in the core.
“Germany rejects a direct lending to European banks of the ESM categorically.”
-German Finance Minister Wolfgang Schäuble
A Short Story
A friend of mine is a quite successful commercial real estate developer in America. He also is a partner in a number of projects outside of the United States. One of his developments is a condo project right in the center of Lisbon. The largest bank in Portugal provided the loan and recently approached my friend to pay off the loan with a substantial reduction in the loan’s amount. While my friend was negotiating the proposal the bank came back to him and said they had concluded that this could not be done even though the offer was made on their initiative. It turns out that the loan had been placed in a securitization that then had been pledged to the ECB for collateral and that the ECB would not release the loan or the security which included it. Now my friend’s group has stopped paying the interest, the condo project is incomplete and standing empty, the bank is probably carrying the debt on their books at face value and the ECB is most probably doing the same so that I would guess that “phantom valuations” are everywhere in the periphery countries and that the magnitude of these types of loans are nowhere reported but clearly of a very large amount. One or two quarters out then the assets may not vary but the declination in the income stream will show up on the balance sheets of the European banks and so I wave the red flag for your consideration.
Growth
I want you to pretend, from now on, that when you see this word it is written in Moldavian and needs to be translated. France and the periphery nations are screaming this word now while almost all of Europe is in recession and one that I believe will be much deeper than forecast. Consequently “growth” does not mean “growth” and the correct translation is “Inflation.” I have long said it would come to this in Europe and here we go. The troubled countries are going to beg and plead for Inflation and Germany, Austria, the Netherlands and Finland are going to resist. With Hollande the most likely next President of France you are going to see a stand-off between the socialist and the centrist countries so that a log jam will develop and the consequences of its uncoupling are anyone’s guess except that it will be likely violent and an extreme series of events. The governance of Europe on May 5 will not be what is found on May 6 and preparation for this should be high upon everyone’s list.
A Significant Announcement
Michael Barnier, the head of Europe Financial Services, announced this morning that he will soon be offering new rules for the debt holders of the European banks. Under the plans, senior debtholders would face losses after shareholders and holders of subordinated debt had their investments wiped out. Write downs may also be applied to bank’s derivatives counterparties, it has been learned, which could be a disaster for other European banks as well as American banks. Counterparty risk will have to be evaluated again after his announcement. Barnier is considering forcing lenders to issue at least 10 percent of their debt in securities that would be eligible for bail-ins and he is also prepared to set out alternative scenarios for debt that could be eligible for write downs. The proposals will also include requirements for national governments to set up so-called "resolution funds," financed by the banks, to cover costs from failing lenders apparently which will add to the liabilities of the European banks. Now one does not consider these types of measures in a vacuum so one would suppose that there are reasons for the implementation of these proposals and that they will go from academic to realization in short order. One more reason to avoid European financial institutions!