Market Rallies on Bungled Stress Test News Release

 

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.

The Federal Reserve released its stress test results of 19 banks two days early yesterday. JP Morgan Chase forced its hand by making a public announcement that it had passed the test. Although the news was not particularly good, nor the results completely believable, U.S. stocks had their best day all year.

The Fed said on Tuesday that 15 of the 19 banks tested would have enough capital, even if they suffered a financial shock.  Citigroup (C), Ally Financial, SunTrust (STI) and MetLife (MET) failed the test. It should be considered shocking that any bank would fail a stress test after all the lavish government bailout and support programs that have funneled considerable amounts of money to them.  The U.S.  government had to semi-nationalize Citigroup and owned 27% of its stock by the time the Credit Crisis was over. Citi received approximately $45 billion in TARP funds alone and when it started paying them back, it got a $38 billion federal tax credit. And it still can't pass a stress test?

Of course, if Citi did pass a stress test, it might bring too much attention to the test's credibility. The Fed claims it set tough conditions and major banks complained that the tests were made too rigorous by considering a scenario where unemployment reached 13% and housing prices dropped 21% (presumably the Fed meant the official unemployment rate being 13% and not the actual rate). While these conditions sound tough, they aren't comprehensive, nor where the attention should be focused.

What prevented hundreds of U.S. banks from failing in 2008 and 2009 was a government willing to provide an effectively unlimited amount of money to keep them afloat.  The feds also propped up the housing market with minimal interest rates and mortgage relief programs and kept the unemployment rate (at least officially) out of double digits by running trillion dollar deficits. It should be expected that these policies will continue, so how could there be any risk to the U.S. banking system?

The policies themselves are creating the risk. Easy money is inflationary and always has been (and no, things will not be different this time). Inflation devalues financial assets and destabilizes banks.  The Fed however denies that inflation exists and that it will exist, so it is not politically tenable for it to do ever include any realistic inflation scenario in its bank stress tests.

Stress tests do not exactly have an unblemished record as is. The ECB tests in Europe passed Dexia bank with flying colors. Only three months later, it was in serious trouble and then it collapsed. Major Irish banks also passed the test, although Ireland itself had to be bailed out shortly thereafter to prevent its financial system from collapsing. Central bank stress tests are essentially public relations gambits meant to tell the public how good things are regardless of the actual state of affairs.

The release of the U.S. stress test also inadvertently revealed the true relationship between the Federal Reserve and the banking system that it supposedly regulates.  Even though the Fed was scheduled to release the stress test results after the market closed on Thursday, Jamie Diamond  announced that JP Morgan Chase (JPM) has passed the stress tests while the market was still open on Tuesday. He also stated that his bank would be raising its dividend and doing a stock buyback. Shortly thereafter, U.S. Bancorp (USB) and American Express (AXP) raised their dividends and announced stock buybacks. Wells Fargo (WFC) and BB&T (BBT) announced that they would be raising their dividend. 

Diamond's announcement forced the Fed's hand and it had to take emergency measures to move its own announcement up. The imbroglio was described by the mainstream media as a "miscommunication" between the Fed and Jamie Diamond. Oh really?  This is quite difficult to accept considering Jamie Diamond sits on the Board of Directors of the New York Fed. A more plausible scenario is that the big banks do what they want and the Fed follows their lead.  This nicely explains how the Credit Crisis came about in 2008 and why the banks will get into trouble once again.

The market rallied strongly on the news starting around 3:00PM with the Dow Jones industrials closing up more than 200 points. Anyone who knew that the accidental "miscommunication" was going to take place made a lot of money.


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.

60% Cut for Greek Bondholders on the Table

 

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.
Bloomberg reported overnight that Greek bondholders were preparing to lose 60% on their investments. This is much bigger than the constructive default of 21% proposed with the second bailout in July. A big cut in the value of Greek bonds will cause major problems for German and French banks — and the ECB itself.

Rumors have been floating around the markets for days about a managed default of Greek debt at around the 50%, or greater, level and an occasional brief or cryptic comment has been made publically by EU officials. While this news was reported by the Helicopter Economics Investing Guide blog days ago, it is only just now filtering into the mainstream news services even though a large cut on Greek debt is an arithmetic inevitability. The only alternative would be a second bailout package several times larger than the proposed 109 billion euros (say 500 billion euros or more). Considering that populations of the EU countries are hostile to spending even the 109 billion euros, additional bailout funding is highly unlikely.

Bloomberg quoted a number of well-placed financial executives, including the CEO of Deutsche Bank, in its report indicating a general consensus was building that Greek bondholders would accept a deep reduction in their holdings. There ECB (European Central Bank) seems to be a major exception however. The ECB had amassed a considerable holding of Greek debt earlier on in an attempt to hold down interest rates there. Interest rates have since gone as high as 141% on Greek one-year governments. The ECB subsequently bought up debt from Portugal, Ireland, Spain and Italy to hold interest rates down in those countries. Investors should expect that ultimately these efforts will prove just as successful as they have in Greece.

Recapitalization (a euphemism for "bailout") will be necessary for EU banks if they have to take major losses on their Greek loans. Dexia, the largest bank in Belgium, folded almost overnight recently and its exposure to Greek debt was only a little over 1% of its loan portfolio — and this was before talk of a 60% haircut for Greek bonds. Imagine what would happen to banks with larger exposures? EU banks also hold substantial amounts of loans to Ireland, Italy, Portugal and Spain. The largest holders of Greek debt by far are of course Greek banks themselves. Proton Bank recently closed there, but officials made it clear that it was because of alleged criminal activity and not because of the debt crisis.

Sovereign credit and bank downgrades throughout the EU are becoming increasingly common.  S&P downgraded Spain's long-term credit rating from AA to AA- with a negative outlook (meaning more cuts are likely) today. The agency predicted Spain would miss its deficit cutting targets for 2011 and 2012. S&P downgraded the credit ratings of a number of Spanish banks three days ago including Santander (STD). Credit Suisse analysts just declared the Royal Bank of Scotland (RBS) to be the "most vulnerable" bank in Europe. RBS is 87% owned by the UK government. Credit rating agency Fitch threatened across the board downgrades of the banks yesterday. This potential downgrade would impact Barclays (BCS), BNP Paribas (FR: BNP), Credit Suisse (CS), Deutsche Bank (DB), Goldman Sachs (GS), Morgan Stanley (MS), and Société Générale (FR:GLE) among others.

Perhaps in the next few weeks there will be some temporary resolution to the Greek debt crisis. Unless the cut that bondholders are forced to take is big enough, it won't last however. Whatever happens with Greece won't solve the problems in Ireland, Italy, Portugal, Spain, and possibly in Belgium. To be effective, the recapitalization (bailouts) of EU banks will have to be substantial. This will by necessity involve using money printing to resolve a debt crisis.  That's actually already been done since 2008 and look at what great shape the global financial system is in now. 

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.

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.