EU Leaders Trying to Avert a Banking Crisis
Although details of plans to finally come up with a solution are few and far between, it does appear that EU leaders are finally getting to the crux of the problem. In short, the powers-that-be look to be coming to grips with the idea that there WILL be defaults on sovereign debt and they will start in Greece. As such, leaders are no longer trying to figure out ways to keep Greece from defaulting and are instead busying themselves with the issue of how best to avert a banking crisis.
In case you aren’t aware, the so-called EU bank stress tests have been a complete farce thus far because banks were allowed to carry sovereign debt on their books at full value. Never mind the fact that the most recent plan for Greece (which has yet to be implemented, by the way) included a haircut for bondholders of 21%. Never mind that the proposed level of the ultimate haircut has been growing on a daily basis and now stands at 50% – 60%. Yep, that’s right; the banks in Europe were still allowed to assume sovereign debt was as good as gold.
The problem, of course, is that Greece IS going to default at some point and everybody knows it. And when they do, the banks are going to take a hit to their capital levels. And as we found out during the failure of Lehman, this can be a bit of a problem when everyone decides to pull their money out of a bank at the same time. Thus, the fact that the EBA (European Banking Authority) now wants banks to price sovereign debt at current market values in the next round of stress tests is a positive. Remember, admitting you have a problem is indeed the first step toward recovery.
So, the fact that EU leaders are finally addressing the proper issues is a good thing. But, as a report out of Credit Suisse points out, fixing the problem may not be so simple. You see, according to the analysts at Credit Suisse, it is estimated that at least 66 European banks will fail this next round of stress tests. This means that these banks will be forced to raise capital (estimates are at ? 220 billion) in order to handle the repercussions of sovereign defaults in Greece. And while identifying the problem is great because it can eliminate fear and uncertainty, the obvious question becomes: Where is that new capital going to come from?
This issue may fall under the category of “once burned, twice shy” as many of the natural providers of bank capital got scorched when doing the same thing for U.S. banks during the initial phases of the U.S. Credit Crisis. Therefore the sovereign wealth funds etc may be reluctant to jump in at this stage of the game. Remember all the talk about the BRICs wanting to lend a hand? Remember also that they quickly reconsidered their statements.
Bringing this full circle, I’m of the opinion that there are three keys to the market right now. First, it would appear that the EU leaders are indeed finally getting to the point. Second, it looks like the markets are giving the EU the benefit of any and all doubt at this time due to the third key – that the U.S. economy does not appear to be crashing and burning the way it did in 2008. Therefore, stock prices are currently being adjusted upward to reflect the improved outlook.
But with the market now back at the top end of the range, it remains unclear how much more upside adjustment is warranted. Stay tuned.
Turning to this morning… A downgrade of UK banks and some weak data out of China has put the market in a defensive mood at the present time. But, of course, that can change in an instant these days.
On the Economic front… Initial Claims for Unemployment Insurance for the week ending 10/8 fell by 1,000 to 404K, which was above the consensus estimate for 405K and above last week’s revised total of 404K (from 401K). Continuing Claims for the week ending 10/1 came in at 3.670M vs. 3.70M and last week’s 3.735M.
David Moenning
Editor: The Daily Decision
