August 30, 2011

Am I Still Worried About Europe?

You bet I am.

Frankly, the fact that more people are not concerned about the European banking situation has me... concerned. My stance remains the same - the Stock Market is a risky place right now. Most of my friends and family members are investors, not traders. They cannot pull their money out of stocks in either individual stock accounts or retirement accounts, immediately. And if the European situation continues, let alone deteriorates, the financial markets could see some fast and furious action - to the downside.

I continue to believe that for the average, prudent investor, the best place to be right now is on the sidelines.

The European Situation

Christine Lagarde, the IMF’s new chief, set off tremors at the Jackson Hole summit over the weekend with warnings that the global financial system is on very thin ice and vulnerable to the slightest shock.

“We are in a dangerous new phase. The stakes are clear: we risk seeing the fragile recovery derailed, so we must act now,” she said.

“Banks need urgent recapitalization. If it is not addressed we could easily see the further spread of economic weakness to core countries, even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization,” she said.

Although it’s encouraging that these issues are getting addressed at the highest levels, Europe’s lenders are already reeling from a share price collapse since the debt crisis spread to Italy and Spain, threatening to overwhelm Europe’s bail-out fund and leave banks exposed to sovereign defaults. We are getting perilously close to a crisis and it is questionable if they aren’t already so far along that anything can be done, let alone if all of the necessary parties are even on the same page as far as what needs to be done.

Europe’s inter-bank market is effectively frozen and EMU banks have lost access to America’s $7 trillion money markets. Lenders have parked €126 billion at the European Central Bank for safety rather than risk exposure to peers. When a bank’s peers are afraid of depositing money with a bank, that should mortify corporate and individual account holders. It will not be surprising at all to see large corporations shunning these institutions and then individuals. What’s going to happen to those institutions that are slow to withdraw? I don’t know the answer – I’d just take steps to ensure that I’m not one of those “last” institutions (or individuals!).

The IMF exhorted Europe’s banks over the last two years to beef up their capital base while the rally lasted. Many failed to do so and will now face harsher terms. Some may fall under state control, wiping out shareholders. The Eurozone economy ground to a halt in the second quarter, tightening the noose on EMU’s weaker states and their banks. Julian Callow from Barclays Capital said Europe is already in “industrial recession” and risks tipping into outright economic slump.

“The recent slide is eerily reminiscent of the pattern during the third quarter of 2008,” he said.

Ms. Lagarde issued a thinly-veiled attack on the ECB’s rate rises and Europe’s fiscal austerity drive. “Monetary policy should remain highly accommodative, as the risk of recession outweighs the risk of inflation. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery,” she said. Note: What she is advocating is turning up the money printing presses. But there’s a problem – Germany, the strongest country in Europe isn’t keen on the idea of sacrificing their decent economic situation to help bail out those countries that have shown neither the want nor desire to implement the economic structural changes necessary to rectify the causes of their poor financial condition.

Additionally, Tim Congdon from International Monetary Research said it is folly to force Europe’s banks to raise money too quickly or crystallize losses abruptly. This will cause a monetary implosion and a repeat of the 2008 disaster. He said the ECB’s restrictive policies over the last 18 months and the lack of EMU fiscal union have doomed the euro. to certain break-up.

“It cannot be saved. Banks will suffer large losses,” he said.

August 29, 2011

Another Banking Crisis?

We are perversely incentivizing the people who run our key financial institutions to take risks. Lots of risk! Because there is little or no downside for them. And we've already been burned from this just a couple of years ago!

From Barry Ritholtz:
"The banking system was not saved. The massive injections of liquidity temporarily soothed day-to-day operations of banks, but they did not repair the more profound troubles. Indeed, pouring billions into nearly identical management teams that mismanaged risk, overleveraged exposure and drove banks off the cliff in the first place was an invitation for another crisis .. They remain stuffed with declining assets, primarily in housing and derivative holdings. Another leg down in housing could be nearly fatal; Balance sheets are unnecessarily opaque; Capitalization: This remains too thin. Leverage should be mandated back to the pre-2005 rule change of no more than 12 to 1.; Misaligned incentives: Compensation and bonus schemes were not significantly changed after the bailouts, except during loan repayments. Thus, management and traders still have the same upside to roll the dice, but they do not have the downside risks."

The U.S. Debt Situation – Putting It Into Perspective:

The U.S. Debt Situation – Putting It Into Perspective:

- New debt: $ 1,650,000,000,000
- Federal budget: $3,820,000,000,000
- National debt: $14,271,000,000,000
- Budget cut: $ 2,100,000,000,000 ( CBO estimated ) / Annualized over 10 years ($210,000,000,000/ yr)

Looking at the raw numbers, it’s hard to put it into perspective. Most people tend to better grasp numbers and concepts when put into terms that they deal with everyday. So, let’s remove eight zeros from these numbers and pretend this is the household budget for the Spendthrift family:

- Total annual income for the Spendthrift family: $21,700
- Amount of money the Spendthrift family spent: $38,200
- Amount of new debt added to the credit card: $16,500
- Outstanding balance on the credit card: $142,710
- Amount cut from the budget: $2,100

So, in effect last month Congress, or in this example the Spendthrift family, sat down at the kitchen table and agreed to cut $2,100 from its annual budget. What family would “solve” their budget issues by cutting that much from their $38,200 spending; $16,500 more than their income? Right… only the Spendthrift’s! And THIS is what the Spendthrift’s in Congress are trying to sell to us – the American public.

August 23, 2011

Europe's Banking Situation

Last week, Nicholas Sarkozy and Angela Merkel got together to talk about the European economic issues. Their response was not amazingly political: what is needed is another eurozone governing body overseeing fiscal debt and promises by governments not to run large deficits. They also said that they will harmonize their tax structures within five years. As John Mauldin notes, the problem is not tax structures, it is debt that cannot be repaid.

Lars Frisell is the Swedish Financial Supervisory Authority Chief Economist - the Swedish group that regulates that nation’s banking system. A few days ago he was quoted as saying:
“It won’t take much for the interbank market to collapse. It’s not that serious at the moment, but it feels like it could very easily become that way and that everything will freeze.”

Porter Stansberry wrote the other day:
“In Europe, the problem is a bit different … and slightly more technical. Most of the debt in Europe is held by the big banks, not the sovereigns. Look at just two French banks, for example. Credit Agricole and BNP Paribas have combined deposits of a little more than 1 trillion euro. But they hold assets of 2.5 trillion euro. Those assets equal France's entire GDP. And those are only two of France's banks. Right now, the tangible capital ratios of these banks have fallen to levels that suggest they are probably bankrupt – like UniCredit in Italy and Deutsche Bank in Germany. BNP's tangible equity ratio is 2.85%. Credit Agricole's tangible equity ratio is 1.41%. (UniCredit's is 4.42%, and Deutsche Bank's is 1.92%).
“These banks have long been instruments of state policy in Europe. They've funded all kinds of government projects and favored industries. Making loans is far more popular with politicians than demanding repayment for loans. As a result, these banks are left with nothing in the kitty to repay their depositors. If there's a run on these banks (and there will be), how will they come up with money that's owed?”

Again, from John Mauldin, "If there is a sovereign debt credit crisis in Europe, it is entirely possible that a majority of Europe’s banks will be technically insolvent, depending on the level of the crisis. Frisell could be eerily prescient. We gave them subprime; they may pay us back with their own crisis and in spades. The next real crisis in Europe that is not bought off with yet more debt will push the world into recession. It is that serious. That is why the ECB keeps ignoring its charter and taking on bank debt and buying sovereign debt they know will be marked down."

Does reading any of this from some very educated people sound like the world's banking system is stable? We are talking BIG European banks. And they are all inter-connected through a myriad of swaps, derivatives, etc... with most of the other large banks in the world. Just out today is a great story that tells us that the bank bailout in 2008 wasn't the $500 billion that was advertised - it was $1.2 TRILLION:
What's going to happen when people really start thinking about these events?

August 20, 2011

Time To Fire Up My Blog

It is time to fire up my blog gain. I am getting the distinct and foreboding feeling that we are entering a very precarious time for the Stock Market and I'd like to use my blog to help as many people as possible. The last time that I felt like this was in October/November 2007. This time period has many of the same characteristics as that time period:
- Many of the major banks in the world have rotten Balance Sheets. One could probably argue that the Balance Sheets were never fixed in the first place.
- Lack of political leadership.
- Downward spiraling consumer confidence.
- A lack of faith in the financial markets.
- The onset of a recession. Again, one could probably argue that we never exited the last recession. Were it not for the massive liquidity inflows from QE and QE2 this would be readily apparent.

But I'm not going to dwell on the reasons for the problems that we're in right now. I'd rather just advise people right now to start taking defensive actions to protect themselves from what promises to be a nasty time in the financial markets.

Barring some currently unforeseen miraculous event, I think it is advisable for people to significantly lighten up their exposures to the Stock Market. We are setting up for what could be a really big drop. I'm not talking about just the U.S. Stock Market, either. I have been and am exiting almost all positive equity exposures. Safe places to put your money would include in cash, U.S. Treasury bonds, money market mutual funds as long as you stay below the FDIC insured limits, and I think that one could also allocate 5 - 10% of their portfolio to precious metals - for the time being. If you need specific instruments to invest in, drop me a line and I can provide some.

I, of course, cannot be certain that I am right. Also, my "call" may also be early, but if the Market tanks like I think it might, I'd rather be early than late. The Market may very well finish off a potential "up" move of several hundred points to complete a "W Pattern", but this will not change the underlying economic problems that we are facing. And I don't feel that staying in the Market is worth the risk right now.

I will post more on the causes and other topics later, but I wanted to get this out tonight. Feel free to make any comments or ask questions in this blog. Chances are that if you have questions that other people have the same questions.