Tuesday, January 17, 2012

Shakespeare understood today’s financial crisis:

Shakespeare understood today’s financial crisis:

 “That struts and frets his hour upon the stage, and then is heard no more: it is a tale, told by an idiot, full of sound and fury, signifying nothing”

Over the past months we have heard, from a multiplicity of re-election seeking political idiots and bonus seeking financial fraudsters, of the EFSF, the ESM, the IMF, bail outs, the FED currency swaps, and the ECB with its LTRO. All of the above have been waved under the noses of the gullible public as a magic solution to the Euro problem.

Let’s for once put the record straight and state the realities in simple terms:

The first problem is that most major European banks, with total assets on average 40 times their equity, are completely bankrupt. They are kept alive by not having to record at market value their “investments” in Sovereign Bonds and other “risk free assets”. Many banks have also made disastrous commercial and real estate loans to economies, particularly in Southern and Eastern Europe. Now in deep crisis, these loans also are massively underwater.

To make matters worse, banks have been instructed under the Basel directives to “strengthen” their equity/lending ratios before June 30, 2012.

This can be achieved by raising new capital. Unicredit the Italian bank made a disastrous attempt to raise cash by a rights issue, which was so badly received by the market the share price dropped over 30%, leading to substantial losses for existing shareholders. This has severely discouraged other banks from doing the same.

The other means of improving ratios is by reducing lending, especially of course to small businesses. This is what the banks did in the US during the Great Depression, thus making the economy even worse.

The last is fire sale of assets, which the banks have been doing, selling viable business divisions, keeping the rest and liquidating Gold and other easily realizable holdings.

The second problem is that the Sovereign countries are themselves hopelessly over indebted, running ever increasing fiscal deficits and teetering on the edge of insolvency, and are in no position to contemplate bailing out their banks.

Many have urgent funding requirements to repay maturing debt, for massive amounts of money, not to mention financing the spiraling deficits. While much noise is made about Greece, France Italy and Spain require to raise EUR 100 – 150 Billion in Q1, 2012 alone.

The ever lengthening list of Sovereign downgrades, by S&P this weekend and recently by Fitch and Moody’s confirm a rapidly deteriorating situation. The desperate attempts by politicians to muzzle these agencies, and downplay the significance of these events, are pathetic.

The rating  agencies, which still follow developments rather than anticipating them, are now finally starting to do their job, after years of complicit actions to dupe investors, e.g. in the sub prime crisis.  Nonetheless, given their ownership structure and dependence on the financial sector and governments for much of their revenues, one can only doubt their degree of independence.

The bankers as always know full well the reality of the situation, and pay little heed to the rating agencies. The true measure of risk is whether banks will lend to each other in the interbank market. Banks are presently afraid to lend to each other as they know there is a serious risk of not being repaid. This problem reached crisis proportions shortly before Christmas.

A bank which can no longer obtain interbank finance goes to the ECB the “lender of last resort” which grants emergency loans, and takes a risk no other bank or sane investor would ever contemplate. Where does the ECB get this money, either from other banks, or from other Central Banks.

Presently the total assets on the balance sheet of the ECB are EUR 2,800 Billion, including massive loans to illiquid / insolvent banks, and a stockpile of PIIGS bonds no-one else wanted to buy.

This gargantuan balance sheet, greater that the GDP of France, is financed inter alia by loans from other Central Banks, including the Bundesbank with outstanding loans of EUR 500 Billion approximately, the FED, estimated to have advanced via a currency swap approximately EUR 1,000 Billion, and of course the surplus cash EUR 500 Billion presently deposited risk free by Banks afraid to loan to their peers, who prefer that the ECB takes the risk in their place.

With a paid up share capital of less than EUR 10 Billion, the ECB is leveraged 280 times and is surely the most bankrupt of all Central Banks.  If the ECB were to mark its investments to market, losses to other central banks, which ultimately mean the taxpayer, would be truly mind blowing.

So how can all these bankrupt countries and banks get the financing required to maintain the Ponzi scheme a while longer, particularly as Mrs. Merkel is strongly in favor of fiscal union, affectionately known as “FU”, but averse to printing money and making bond purchases?

Enter the new ECB boss, and former Goldmanite, the self styled “Super” Mario Draghi. He is infinitely smarter than the German Chancellor and has effectively bypassed her, by granting virtually unlimited loans to cash strapped Euro zone banks, against which the ECB will accept almost any form of security. This enables banks to offload worthless Sovereign bonds, at full book value of course, and perhaps even unwanted Christmas presents. These are 3 year loans, Long Term Refinancing Operations (“LTRO”). This is totally against the spirit of a Central Bank role of providing emergency overnight funding, but these days nobody seems to care.

The ECB hope was that banks once again flush with cheap liquidity, would buy up further Sovereign debt that the ECB was prevented from buying not only by its charter, but also of course by Mrs. Merkel.

The banks took the money EUR 489 Billion to date with more at end February, with open arms and immediately parked it back at the ECB. As one banker said, our shareholders would take a very dim view of investing in Sovereign debt when we can strengthen our own balance sheet, in advance of the Basel imposed capital requirements.

The LTRO so far has been a complete failure, but this will definitely not stop the ECB, whose priority is in saving the banks, doing the same thing over and over again, until perhaps eventually some money will flow into the Bond market.

This leads us to the EFSF, covered in a previous blog post. All attempts to raise significant capital have failed, and the idea of leveraging the fund was still born. Now the situation is much worse as the recent S&P credit rating downgrades have resulted in a downgrade of the EFSF itself.

The ultimate joke will come when the rescue fund, if it is ever funded, ends up with a lower credit rating than many of the countries it is designed to save!!!!!  

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