Friday, 01 June 2012 05:15

Sophisticated Ignorance Part 2: Pressuring Germany To Do The Wrong Thing Is A Short Seller's Dream Featured

Today's lead story on Bloomberg and the primary theme throughout the financial MSM is Merkel’s Isolation Deepens As Draghi Criticizes Strategy. This is general pressure to force Merkel to succumb to extreme short term thinking that will most assuredely bring the EU to its knees and potentially end the hegemony of what use to be the European empire - that is unless... You know.... This time is different! Yes, these are strong words, strong words are necessry for a dire situation. Let's consder this a massive economic changing of the guard, shall we. And as such, these occurrences portend the potential for MASSIVE speculative investment gains as those financial bastions of faux capitalism come toppling down amidst massive short positiions that the majority simply didn't have the foresight, temerity (or balls) to impliement and hold on to. At the end of this article, I will review FIRE sector (see Reggie Middleton Sets CNBC on FIRE!!! and First I set CNBC on F.I.R.E., Now It Appears I've Set and Greece Is Trying To Convince Portugal To Make F.I.R.E. Hot!!!) entities that I feel are primed to pop as this plays out, yet are not priced accordingly.

On Thursday, 29 September 2011 I penned Sophisticated Ignorance Or Just A Very, Very Short Term Memory? Foolish Talk of German Bailouts Once Again, wherein I queried:

"If I were able to show in this article that it really ISN'T different this time, would it change any decision maker's path or actions? We all know the answer to that question. Time to get those outlier event short positions ready, it's going to be a rough ride!!! A complete recap of recent events..."

This is a very important post, for it will lay out the outline of the impetus behind the 450+% gains I achieced in 2008/9. As queried in the afore-linked article, "So, at what point do we ever learn the basic lesson that "You can't solve an indebted nation's debt problems with more debt"?" 

The original "Sophisticated Ignorance" post was made in response to Germany being lauded for voting to nearly double the size of the then largest EU bailout fund ever...  

German lawmakers approved by a wide margin legislation to boost the scope and size of the euro zone's rescue fund, in a major step toward tackling the bloc's sovereign-debt crisis.

Lawmakers passed the reform of the European Financial Stability Facility with 523 'yes' votes, while 85 lawmakers voted 'no' and three abstained. The vote was seen as a test of Chancellor Angela Merkel's center-right coalition.

All 17 euro-zone governments have to approve the expansion, which will boost the fund’s lending capacity to €440 billion ($595.94 billion) from €250 billion and expand its powers to allow it to extend credit lines to banks and buy bonds on the secondary market.

To conitnue to quote from "Sophisticated Ignorance"...

This was the problem that I had with Paulson's original TARP idea. It just won't work because it doesn't solve the problem. Instead, it attempts to conceal the problem in fashion that pretends it never existed. Let's walk through this so a 5 year old can understand it.

Of course EU governments will try to bail out their banks again. The issue is that the bailout is not the question, neither is the success of said bailouts (this is rather a trick question, since the soveriegn states simply cannot afford to bailout their banks any more than a 100 lbs man can lift a 400lbs man). The fact of the matter at hand is that they simply can't afford to bail them out. The banking system is just too big. 


As BoomBustBlog's above average prescience (see Pan-European sovereign debt crisis) and Reinhart and Rogoff, of This Time Is Different: Eight Centuries of Financial Folly have clearly demonstrated, the source of the sovereigns debt problems is related DIRECTLY to the attempt to bailout insolvent banks, taking private sector losses upon public balance sheets, and eventually bankrupting the public state while doing nothing to fix the problems of the private banks, and ulitimately witnessing the private banks fail anyway.

I have predicted FIRE sector (including banks) failure at a commendable rate (see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall

Subscribers, please reference the following documents analyzing the FIRE companies we see at risk as a result of the following circumstances.

We have reviewed the finance portion extensively throughout 2011. See Commercial & Investment Banks section of the subscription content area. This is the latest bank who we feel will suffere significant if the feces hits the fan blades  Bank Haircuts, Derivative Risks and Valuation.

I have also detailed the risks in commercial real estate in the Dutch markets, see

Now available for download to all paying subscribers is a US REIT headed for distress -  US Commercial REIT Distress Overview
(Commercial Real Estate)
. Professional and institutional subscribers will have an addendum published with additional companies that just missed the shortlist, but may see problems in the near to medium term.

Streets Best of the Best?). It's not rocket science, though. It's simply (and actually quite simple, since my 10 year old can do it) math, coupled with a pliable understanding of human nature couped in grasp of history. Listen, it was the (attempted) bailing out of the banking system that got these countries in this situation to begin with. Bailing out the banks just two years later??? Do you really thing that will help the sovereign debt situation or hurt it? If the bailout goes through, you eat the small losses (relative to the big gains that BoomBustBlog delivered subscribers) and roll your gains directly into bearish positions on the bailing sovereigns. It's really just that simple. Don't believe me, let's look at history, and remember that that is Germany being referenced in the graphic below, G-E-R-M-A-N-Y!!!


On that note and after a quick education on how this time is no diffeent than any other time in the past 800 years, let's revisist today's MSM headline, ala Bloomberg... 


Merkel’s Isolation Deepens As Draghi Criticizes Strategy 

German Chancellor Angela Merkel was besieged by critics for letting the euro crisis smolder, with the leaders of Italy and the European Central Bank demanding bolder steps to stabilize the 17-nation economy.

Italian Prime Minister Mario Monti and ECB President Mario Draghi pushed Germany to give up its opposition to direct euro- area aid for struggling banks. Monti further antagonized Germany by urging a roadmap to common borrowing.

Calling himself a devotee of German-style budgetary rigor, Monti told a Brussels conference yesterday that Merkel’s vision of a stable economy “risks being undermined because of lack of promptness in setting up the necessary instruments to limit the contagion.”

And therein lies the rub. You see, creating a direct conduit to zombie banks from teh ECB and bailout mechanisms will not limit contagion, it will materially exacerbate it by allowing the financial pathogens direct access to the mothership - the ECB! Look at the history of the western world for over 800 years. THE BAD BANK BAILOUT IDEALOGY SIMPLY HAS NOT WORKED, EVER!!!

Financial markets offered a snapshot of Europe’s stresses after more than two years of crisis, with the euro close to its weakest in two years against the dollar. German two-year note yields fell below zero today as investors paid for shelter from the market mayhem afflicting Italy and Spain.

“Countries that are at the core of the system and which have had the huge merit of instilling the culture of stability to the European Union in the first place, most notably Germany, should really reflect deeply but quickly,” Monti said via video link to the Brussels conference. “Europe should really accelerate the efforts, as the European Commission is doing, in order to limit the contagion.”

Oh yeah, I've commented on this in the past as well. What happens to a net export nation's economy when all of its export partners are in recession, depression, war and socio-political unrest while the banking system unfolds around them? The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You...

As Germany goes, so does the insurance industry's magically levitating FI porfolio. You see, German gains offset periphery losses. What happens when everyone realizes Gemany may be in the penthouse suite, but still resides in the same overindebted roach motel?

European banks are (in addition to borrowing on a secured basis from those customers they usually lend to) also paying insurers and pension funds to take their illiquid bonds in exchange for better quality ones, in a desperate bid to secure much-needed cash from the ECB, which only provides cash against collateral. This may not be as safe a measure as it sounds. Below is a sensitivity analysis of Generali's (a highly leveraged Italian insurer, subscribers see File Icon Exposure of European insurers to PIIGS) sovereign debt holdings.


As you can see, Generali is highly leveraged into PIIGS debt, with 400% of its tangible equity exposed. Despite such leveraged exposure, I calculate (off the cuff, not an in depth analysis) that it took a 10% hit to Tangible Equity. Now, that's a lot, but one would assume that it would have been much worse. What saved it? Diversification into Geman bunds, whose yield went negative, thus throwing off a 14% return. Not bad for alleged AAA fixed income. But let's face it, Germany lives in the same roach motel as the rest of the profligate EU, they just rent the penthouse suite! Remember, Germany is not in recession after a rip roaring bull run in its bonds, and I presume the recession should get much deeper since as a net exporter it has to faces its trading partners going broke. Below you see what happens if the bund returns were simply run along the historical trend line (with not extreme bullishness of the last year).


Companies such as Generali would instantly lose a third of their tangible equity. This is quite conservative, since the profligate states bonds would probably collapse unless the spreads shrink, which is highly doubtful. Below you see what would happen if bunds were to take a 10% loss.


That's right, a 10% loss in bunds translates into a near 50% loss in tangible equity to this insurer, which would realistically be 60% plus as the rest of the EU portfolio will compress in solidarity. Combine this with the fact that insurers operating results are facing historically unprecedented stress (see You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses!) and it's not hard to imagine marginal insurers seeing equity totally wiped out. The same situation is evident in banks and pension funds as well as real estate entities dependent on financing in the near to medium term - basically, the entire FIRE sector in both European and US markets (that's right, don't believe those who say the US banks have decoupled from Europe).


If you ddin't put your short on Generali back in 2010 when I first brought it to subscriber's attention, then it's too late now. It's not too late to jump on our latest insurance industry subject, though. The last forensic report was centered around an insurer - see You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses! and Our Next Forensic Analysis Subject Is In The Insurance Industry. The actual report is available here:

Bank runs are invevitable! 

As excerpted from our professional series File Icon Bank Run Liquidity Candidate Forensic Opinion:


This is how that document started off. Even if we were to disregard BNP's most serious liquidity and ALM mismatch issues, we still need to address the topic above. Now, if you were to employ the free BNP bank run models that I made available in the post "The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download"" (click the link to download your own copy of the bank run model, whether your a simple BoomBustBlog follower or a paid subscriber) you would know that the odds are that BNP's bond portfolio would probably take a much bigger hit than that conservatively quoted above.  Here I demonstrated what more realistic numbers would look like in said model... image008image008

Yes, European bank runs are inevitable, but the causes of the bank runs are not. That's the problem. Instead of addressing the root causes of the bank runs, EU decision makers opt to throw more paper money into a gaping furnace to be burned as fast as it can be shoveled. 

Since the problems have not been cured, they're literally guaranteed to come back and bite ass. Guaranteed! So, as suggested earlier on, download your appropriate BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional), read the balance of this article for perspective, then populate the assumptions and inputs with what you feel is realistic. I'm sure you will come up with conclusions similar to ours. Below is sample output from the professional level model (BNP Exposures - Professional Subscriber Download Version) that simulates the bank run that the news clippings below appear to be describing in detail...(Click to enlarge to printer quality)


A detailed and accurate picture of what is happening...

  1. Now That European Bank Run Contagion Has Started Skipping Across That Big Pond... US Bank Risk Stands Woefully Underappreciated!!!
  2. The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download
  3. BNP Bust Up: Yet Another Reason Why BNP Paribas Is Still Ripe For Implosion!
  4. Most Headlines Now Show French Bank Run Has Started, And It's Happening Just As Our Research Anticipated
  5. I Will Fly In The Face Of Common Wisdom & Walk Through A Run On BNP On International Television
  6. And The European Bank Run Continues...

A step by step tutorial on exactly how it will happen....

Stacy Summary: We interview Reggie Middleton about a run on French banks. I notice today that Pimco’s El-Erian is also talking about a run on French banks. He must have watched the Keiser Report when it aired from late last night PDT. We know you’re taking our shtick Mr. El-Erian, we’ve got our eye on you!

Go to 13:07 marker in the video, contrast and compare and consider watching the smaller more independent shows for the real scoop every now and then.

For some back ground on the "Kick the Can Triumvirate Three" [BBB Trademark], go to 20:50 in the video and dedicate 5 minutes to it...

My April presentation in Amsterdam as Keynote detailing the inevitable...

Amsterdam's VPRO Backlight and Reggie Middleton on brutal honesty, destructive derivatives and the "overbanked" status of many European sovereign nations

Amsterdam's VPRO Backlight and Reggie Middleton on brutal honesty, destructive derivatives and the "overbanked" status of many European sovereign nations

Again, I believe the next big thing, for when (not if, but when) European banks blow up, is the reverberation through American banks and how it WILL affect us stateside! Subscribers, be sure to be prepared. Puts are already quite costly, but there are other methods if you haven't taken your positions when the research was first released. For those who wish to subscribe, click here.

Note: This bank has members of its peer group who have been identified as at risk, but no one has pulled the covers off of this one as of yet. I think I may blow the whistle. It will be a doozy, and a potentially very profitable one at that since nearly 3/4 of it tangible equity is embroiled in a region that looks like it is about to blow up. As I type this, some of the puts have already doubled in price. I will be releasing additional analysis on this bank this weekend for paying subscribers.


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