Friday, 23 July 2010 12:07

European Bank Investors, Don't Look Now - You've Been Hoodwinked, BamBoozled...

Personally, I consider the European bank stress tests to be a farce; an attempt to Bamboozle, Hoodwink and Dis-inform any who would be naive enough to drink the Kool-Aid - not to dissimilar from the US bank stress tests (see You’ve Been Bamboozled, Hoodwinked and Lied To! Here’s the Proof). CNBC reports that "NO" default scenarios will be played out, which I find to be rather unrealistic since the reasons why the banks are enjoying restricted access to the capital markets is the fear of default! Think long and hard about this...

You are showing signs of HIV, and nobody wants to come near you, make love to you or lend long term to you due to the symptoms of this most unpleasant and deadly disease despite the many proclamations you have made to the contrary. You decide to set the record straight by visiting a prominent doctor to diagnose your issues and placate your associates. The doctor comes up with a prognosis, but simultaneously declares that:

  • AIDS (the syndrome), and death have not and will not be considered because the doctor will not let any of his patients catch AIDS or die! Whaaatt!!!??? Does the doctor really have that much control over who catches diseases and who dies? [Analogous to refusing to even consider the potential for default on sovereign debt, as if no European country has ever defaulted before - many have, and many probably will in the future as well). This analogy actually serves us quite well for the ECB has very limited control over who gets sick and how the contagions (both financial and economic) are transmitted (see below).
  • The patient will be assumed to operate between 96% and 57.8% efficiency. This is, of course, a problem if the patient truly is terminally ill, for his health should receive significantly more of a.... Well, a haircut.
  • Only the patient's mucous membranes and other very short-lived tissue will be considered for examination, for the patience plans on keeping other body parts for the long term, hence they should not be affected by fluctuations by any potential illness. Yes, I know this statement doesn't make any damn sense, but then again neither does the ECB excluding hold to maturity and portfolio inventory from the stress tests either. It really doesn't matter how long you plan on holding said items, if they are permanently impaired in value, then they are permanently impaired, Right???!!! I know, we won't even consider a default scenario, but since countries do default.. If a default occurs, or more realistically a restructuring, then wouldn't longer term inventory be impaired - Permanently???!!! In the post A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina I demonstrated how much damage was done to the Argentinian bond holders after their restructuring. Too bad the Argentinian investors didn't have the all-powerful ECB there to declare that restructuring and default are not part of the rules, hence not allowed. The following is the price of the bond that went under restructuring and was exchanged for the Par

bond in 2005

image001

Price of the bond that went under restructuring and was exchanged for the Discount bond

image003

With this quick historical primer still fresh in our heads, let’s revisit our Greek, Spanish, and Italian banking analyses (the green sidebar to the right), many of which are trying to push the 400% mark in terms of returns if one purchased OTM options at the time of the research release. It may be worthwhile to review the Sovereign debt exposure of Insurers and Reinsurers as well. A quick glimpse at our calculated restructurings are in order as well...

  1. With the Euro Disintegrating, You Can Calculate Your Haircuts Here”

  2. What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates

  3. The ECB and the Potential Failure of Quantitative Easing, Euro Edition – In the Spotlight!

  4. Introducing the Not So Stylish Portuguese Haircut Analysis

  5. A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina

So, the patient pays this doctor money for his opinion, shows the opinion to all of if friends, business partners, lovers and associates and they all pretty much tell him to stay the hell away from them. Why??? For one, it's not so much that he probably has HIV and/or AIDS - for many people have it and are still living productive lives, but moreso that he is demonstrably dishonest and unrealistic about his situation, and therefore cannot be trusted. This is where I stand with the European bank stress tests. You literally invalidate everybody's results by trying to slip a few (or maybe a whole lot of) sick banks under the covers. The patient above may very well have been healthy, but we will not know and never trust him due to the silly games that were played. Of course, if he was healthy, there really would be no need to play the games in the first place, now would there?

foreign claims of PIIGS

See The BoomBustBlog Sovereign Contagion Model for more on this topic. From CNBC:

SOVEREIGN SCENARIO:

-  No default applied

- Starting point is the value at the end of 2009

-  Haircuts were applied to all EU government bonds (even Germany - 4 percent for a 5-year bond)

-  Haircuts were applied to trading books only

-  Portuguese 5-year bonds haircut: -14 percent [BoomBustBlog estimates are considerably higher, see Introducing the Not So Stylish Portuguese Haircut Analysis]

- Germany 5-year bond haircut: - 4 percent

- A 10-year Greek bond would have a 42.2 percent haircut if a long-term interest rate that was 5.77 percent at the end of 2009 would surge to 14.69 percent at the end of 2011. [Subscribers can see our estimates here A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina]

-  In this case, a 5-year Greek bond would see a fall in value of 23 percent.

Interested parties can read the entire 50+ article Pan-European Sovereign Debt Crisis series by clicking here. You can subscribe here.

Last modified on Friday, 23 July 2010 12:07

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