Is Dexia Bank the Bear Stearns of the Current Credit Crisis?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Over the weekend French President Sarkozy and German Chancellor Merkel said they had come to an agreement on recapitalizing EU banks. No details of their mystery plan were released. Plenty of details were forthcoming however on how Dexia bank was going to be bailed out and they indicate that it's time for EU leaders to stop talking and to start acting. 

Before its recent failure, Dexia bank was described as one of the strongest banks in Europe. It had no trouble passing the recent EU stress tests for banks (so much for the accuracy of those tests, which I have maintained for some time are nothing but a meaningless public relations gambit). Its Greek debt exposure was cited by the mainstream media as a primary reason for Dexia's demise. Dexia though had only 5.4 billion euros of Greek debt on its books out of an asset base of 518 billion euros according to Bloomberg. So, Greek debt was a little over 1% of Dexia's loans. Apparently this was enough for wholesale funding for the bank to dry up. Like most banks, consumer deposits were not enough to maintain Dexia's operations, it needed to continually borrow in the interbank market.

Dexia was a Franco-Belgium bank created 15 years ago by a merger of banks from the two countries. It also operates in Luxembourg and owns a 75% stake in Denzibank AS in Turkey, which it purchased in 2006. The Belgium government agreed to buy Dexia for 4 billion euros.  The French and Luxembourg units will be sold. Together, the three European governments will guarantee 90 billion euros of interbank and bond funding for 10 years. Belgium's share will be about 15% of its GDP. Guaranteeing bank debt has its risks and this is why Ireland required an EU bailout. Could Belgium be next?

If Dexia can fail, what EU bank is safe?  Moreover, the failure happened without a default by Greece, so it is clear many more bank failures are possible regardless of the outcome of the Greek debt crisis.
It can also be assumed that default will make the situation much worse. There are reports from German news agency DPA that Eurozone finance ministers are working on a plan involving a 60% reduction in Greek debt (previous reports indicated a 50% reduction).

The recent Dexia failure just like Bear Stearns failure in March 2008 happened because confidence from lenders in the interbank market disappeared. This can happen overnight. The monetary authorities patched things together temporarily after Bear Stearns demise, but the overall situation continued to deteriorate until Lehman Brothers failed six months later. A Greek default is likely to be the Lehman moment for the current credit crisis and Dexia's sudden collapse is similar to Bear Stearns. More bank failures in the EU will be a warning that the current crisis is escalating out of control.

Disclosure: None
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.
 

BOE Kicks Off New Global Money Printing Cycle

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Markets like money printing. The Bank of England (BOE) today announced its own QE2.  Statments from Fed Chair Ben Bernanke and talk of the EU recapitalizing its banks was already juicing up global stocks before the BOE took this earlier-than-expected action.

In its latest round of quantitative easing, the BOE will be purchasing 75 billion pounds in bonds. While some news reports euphemistically described this action as the BOE will be "spending" the money, the correct phraseology is that it will be "printing" this money. The BOE has previously printed 200 billion pounds to buy bonds starting in 2008 during the first credit crisis. The U.S. Fed has already engaged in two rounds of quantitative easing (only one of many ways that money can be printed) and a third should be expected.

Stocks had already turned around on Tuesday with big rallies. Fed chair Ben Bernanke made a statement that he was willing to do more to help the economy. Bernanke has been "helping" the economy since he started lowering the fed funds rate in September 2007. While he has helped the economy, the U.S. has experienced the worst recession and worst bear market since the Great Depression in the 1930s, the official unemployment numbers have remained close to double digits, the U.S. has had the largest number of bank failures since the Savings and Loan crisis, and thanks to his quantitative easing, the U.S. has been able to run a series of trillion dollar plus budget deficits that are going to lead to serious problems in the future.  Why shouldn't markets rally with more of that in prospect?

In the short term, markets don't care about dire consequences that are somewhere down the road. They rally based on liquidity and money printing provides it for them. While the news that the EU is going to recapitalize its banks sounds positive, there is little if any discussion in any article about where the money is going to come from. For the answer, picture a giant printing press spewing out fresh euro bills at break net speed. Investors should also expect a lot of nationalizations as part of this process. Belgium has just announced it will take over failed bank Dexia (described by the news media as "troubled"). Dexia is the largest bank in the country.

Market volatility is common during credit crises. Investors should expect continued market selloffs interspersed with big rallies. Ultimately, money printing will not save the day however because real value can't be created out of thin air. The day that will happen, is the day that PIIGS will fly. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Will EU Accept Greece's Trojan Horse of Debt?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


International markets are looking for resolution to the debt crisis in Greece. European Union leaders have a summit meeting on February 11th and either a debt restructuring or a bailout of some type is on the wish list of traders. Whatever happens however will only be at best a temporary solution that will delay the day of reckoning for the global financial system. In the short-term, it will not undo the damage done to the euro nor to the stocks and commodities that have been impacted by the currencies current drop.

The problem in Greece is neither new nor exceptional for the EU. The conditions of the currency union in the euro zone have been violated from day one. The Maastricht Treaty set a limit for budget deficits of 3% of GDP and a 60% limit for the debt to GDP ratio of participating countries. The euro was launched in 1999 and replaced individual country currencies in 2002. Germany itself, the economic powerhouse of Europe, had a budget deficit of at least 3.7% between 2002 and 2004. France also violated the treaty conditions within the first three years, as did Portugal. The Netherlands did so in 2003. Initially Greece appeared to be in compliance, but was later accused of manipulating its statistics (a historical commonplace for fiscally irresponsible governments) and later admitted that its budget deficit averaged 4.3% between 2000 and 2004.

The euro currency union actually helped countries reduce their budget deficits by lowering their borrowing costs. When the debt to GDP ratio becomes large, reducing interest payments can reduce the budget deficit considerably. This phenomenon benefited Italy tremendously. Interest rates on Italian government bonds fell from around 12% in 1994 to 4% in 2004. It also improved the situation in Belgium. Belgium's debt to GDP ratio was 134% in 1993, but only 90% in 2008. It has never gotten anywhere close to the 60% limit. Italy's debt to GDP ratio in 2008 was 106% and is growing rapidly. It will not be long before it reaches Greece's 120% level. Yet, the market is focused more on Portugal with an 85% ratio - equivalent to the official numbers in the United States (the actual numbers are similar to Greece's) and Spain which has only a 66% debt to GDP ratio.

The EU rules don't have any provisions for bailing out one of the members of the currency union. Such legal niceties though can easily be ignored during a crisis. The EU executive committee has furthermore previously maintained that no bailout of Greece will be needed. Mid-day on February 9th however, news was released stating that the euro zone countries have decided in principle to aid the debt-stricken country. Reports indicated that the EU authorities were considering a range of possible actions, but no specifics were given. The euro of course rallied strongly on the news.

The euro has traded down from a high around 1.51 to the U.S. dollar in late November to the 1.36 level on February 5th. It is trading well below its 200-day moving average at the 143 level. The 50-day moving average, also at the 143 level, is about to cross the 200-day and trade below it, giving a classic bear trading signal.  The euro will not be able to recover from this technical damage overnight. Nevertheless, sharp counter rallies are inevitable since short positions on the euro have reached a record. This will create conditions for a nice longer-term rally in the future, but a period of volatility is more likely first. Commodities, particularly the precious metals, and U.S. stocks tend to trade with the euro, so investors should expect them to follow this pattern as well.

Disclosure: No Positions

NEXT: Economists and Governments Pave the Way for Global Inflation

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.