The news today continues the rumoring that Italian banks and bonds are going to see problems this year or early next year. This follows an interesting email exchange (dated the 8th) that I had concerning our European bank and soveriegn research from last year.

• Italy public finances projection
• Italian Banking Macro-Fundamental Discussion Note

Of note, please look at the charts from Mish.

Italy has clearly recently broken the 5% support, and if on a tech point of view, a quick 40bp is guaranteed, to 5.4% (the previous range was 4.6%-5% so 40bp wide), given the context, and given that German yields are going DOWN, this is the sign of something much much bigger, like what happened to Spain and perhaps Portugal. Youve seen the info as well on the recent volatility in Italian banks, and headlines shifting to Italy, I now believe the big move is happening right now. The european leaders must be shitting in their pants.

Actually even the spread France vs Germany seems to be going out of its range, thats a new thing. There can be gaps if a new bond is issued, but I've noticed a much bigger than usual gap this day, so something is going on, I've asked a trader as well if something was going on with french oats, there is definitily a significant move.

And on that note, the following Monday: European Stocks Decline on Italy Debt Concern, China Inflation

European stocks fell for a second day as concern grew that the region’s debt crisis will spread to Italy and China’s inflation surged to a three-year high. Asian shares and U.S. index futures slid.

Intesa Sanpaolo SpA (ISP) retreated as Italy’s second-biggest bank was downgraded at HSBC Holdings Plc.

Page 6 of our proprietary Italian banking research - ( Italian Banking Macro-Fundamental Discussion Note) reveals what we percieved to be weakness in this bank back in February of 2010 with an increasing Texas ratio and increasig proportional NPAs.

As for China, well according to China Is In a Self-Imposed Bubble That Has Nowhere To Go But Bust! You Don't Get Something (Growth Through Stimulus) For Nothing (No Economic Consequences)...

Now, it didn't take a genius to figure out this would happen. As a matter of fact a slight dose of common sense (when was the last time you got something for nothing, really?), a little historical perspective or a BoomBustBlog subscription would have sufficed.

• BoomBustBlog China Focus: Inflation? Thursday, May 20th, 2010
• Can China Control the “Side-Effects” of its Stimulus-Led Growth? Let’s Look at the Facts Wednesday, February 3rd, 2010
• What Are the Odds That China Will Follow 1920’s US and 1980’s Japan? Wednesday, March 10th, 2010
• BoomBustBlog China Focus: Interest Rates Thursday, May 20th, 2010
• My China Ruminations Have Come to Pass As the Country Enters a Bear Market Tuesday, May 11th, 2010

From Bloomberg: China Inflation Accelerates as Loans Surge, Property Prices Rise by Record

May 11 (Bloomberg) — China’s inflation accelerated, bank lending exceeded estimates and property prices jumped by a record, increasing pressure on the government to raise interest rates and let the currency appreciate.

Consumer prices rose 2.8 percent in April from a year earlier, the fastest pace in 18 months, and property prices jumped 12.8 percent, the statistics bureau said in statements today. New lending of 774 billion yuan ($113 billion), announced by the central bank, was more than any of 24 economists forecast.

• Chubble (The Unmistakeable, Yet Thoroughly Argued Chinese Bubble), Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other News Thursday, April 15th, 2010
•  Now That the MSM and Chinese Officials Admit There Is a Bubble In China…Tuesday, July 20th, 2010
•  Will the Emerging Markets Lead the World to New Growth? Wednesday, July 7th, 2010,

Excerpts from the HSBC forensic analysis featured in this post:

Below are the full forensic reports available for download to subscribers (click here to subscribe):

HSBC 170610 Professional & Institutional (554.65 kB 2010-07-07 06:23:52)

HSBC 170610 Retail (388.56 kB 2010-07-07 06:22:25)

As illustrated in Why The Taxpaying Populace Of Greece Better Get Some Grease, a visual representation of Greeece's gross government debt easily demonstrates that their problems are structural in nature, and not cyclical...

image002

What does this mean? Well, first of all, bailout loans only help in cyclical situations where the loan recipient is in a downtun in its ecconomic cycle, but expects upticks to allow it to earn its way out of both its current economc situation and the added debt service from the bailout loans. As you can see from the chart above, Greece's expenditures have literally been a permanent fixture hanging considerably above its revenue, considerably above. For twenty years, Greece has been kicking the inevitable can down the road. Now, after a global credit implosion, with:

1. asset values plunging
2. and economic activity stagnating
3. with the promise of even more stagnation down the pike in the form of intense austerity programs
4. material push back from the labor forces, unions, and the few legit taxpayers there are
5. and collapsed asset values that were perpetually overstated in and attempt to sell to fill the void left by the credit crisis
6. an insolvent banking system stuffed to the gills with bonds trading at 50 cents on the dollar held at par at 40x leverage, NPAs bulging and mismarked,
7. rates about to spike
8. trading partners undergoing their own austerity programs reducing exports and tourism
9. and most importantly tens, if not hundreds of billions of Euro in bailout funds with collateral strings attached...

Greece is somehow expected to earn its way out of this 20 year hole that was made lethal by the Pan-European Sovereign Debt Crisis. Does anyone really think this will happen, or is Greece getting set up to have its assets confiscated at firesale prices. Is the Greek culture up for highly discunted volume sale, Walmart style?

A Quick Backgrounder

Advanced economies continue to face challenges as they deal with the juxtaposition of a huge public finances, mounting debt rollovers, a still-impaired financial sector at a time when economic growth is at snail’s pace, and unemployment levels & social unrest are at unprecedented levels. Expansionary fiscal policy in the wake of the financial crisis has helped banks repair their balance sheet and reduce leverage. Indeed, the public indebtedness has replaced private indebtedness. Current budget deficits, partly cyclical were also swollen by policy responses to the crisis, and are large in relation to GDP.

Notable decline in national incomes as a result of slower growth and increased government expenditure, thanks to huge bail out packages, have caused a dramatic deterioration of fiscal positions in many industrial economies. Growth in Public debt is unlikely to be halted any time soon as economic recovery will be slow, tax revenues will be lackluster, and expenditures are expected to continue their march north. Tax revenue is not expected to reach pre-crisis levels sooner as most of the tax revenue was windfall, thanks to the boom in financial, credit, real estate & construction markets. With aging populations many industrial countries are expected to face rising pension and health costs, beyond 2011.

 In addition, rising interest rates will exacerbate interest payments. In short, deficits are expected to remain at unsustainable levels not just in the near-term but also in the medium term posing a heightened risk of L-shaped economic scenario in the entire Western world. In addition, the deterioration of fiscal balances could also impede central banks’ task to keep inflation at stable levels. The ultimate cost of cleaning up the financial system is still unknown, but we do know this – it is significantly larger than nearly all policy makers anticipated and it morphs and transforms as if it were a sentient being attempting to avoid capture.

Banks in several large and strategically pertinent countries are still fragile while being exposed to volatile financial markets and a deteriorating commercial real estate market at the same time that global interest rates are poised to enter a nearly unprecedented period of volatility. This “perfect storm” of ingredients leave the FICC businesses of these fragile banks open to significant ruin, as detailed in our article The Next Step in the Bank Implosion Cycle???

To make matters worse, the financial intertwining of European economies over the past decade has only increased the costs of such spill over. The dominant theme within the credit market currently is the fears over the solvency of peripheral European sovereign.

image007_copy

The market focus on $12bn debt roll over by Greece is myopic. Even if Greece is able to restructure $12bn of debt, the next trance would not be more than a year away, and an even greater need the following year, with a greater portion of debt the year after that. Overall, Greece has $55bn of debt maturing over the next 12 months and $195bn over next five years. To give a perspective, Greece has to roll over debt equating to 17% of its GDP (a number which is most likely overstated) over next 12 months compared with 14% for Spain, 12% for Portugal and 6% for Ireland. Total debt rollover over the next five years is c60% of GDP for Greece, 43% for Portugal, 34% for Spain and 24% for Ireland.

CNBC reports European Banks Increasingly Angry Over Stress Tests.

Yer damn skippy. Look what really happens when Greece needs the Grease,

As excerpted from It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking Crisis

If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…

Despite the fact that the only way out of this is a true default and destruction of the debt capital proffered during profligate times, TPTB will try their best to find a workaround, because what's best for the people of Greece, Portugal, Ireland and as we have already seen - Iceland, is absolute anathema to the bankers that binged on this stuff at 40x leverage ans sitting on 50% devaluations as we speak. You simply do the math: 40 x (-50%) = what kind of returns? Insolvency, first and foremost!

Subscription Document Archive:

Greece Public Finances Projections

Sovereign Contagion Model - Retail (961.43 kB 2010-05-04 12:32:46)

Sovereign Contagion Model - Pro & Institutional

Greece and fellow members of the PIIGS group of distressed sovereign states are considerably worse off than those tumulted by the Argentenian debt crisis of the '90s. Here's why...

CNBC reports: In Europe, an 'Argentinean Re-Run': Fund Manager

The situation facing European countries like Greece and Portugal is directly comparable to the economic crisis which hit Latin America in the late 1990s, Andy Brough, co-head of Schroders’ Pan European Small and Mid Cap team, told CNBC Wednesday. 

"I get the feeling we're having an Argentinean re-run," Brough said. "In Europe, they've tried everything to sustain the system but it's unsustainable."

Argentina, together with the region's largest country Brazil and with Uruguay, suffered a sustained economic crisis last decade after building up a huge debt pile.

Argentina in particular continued to borrow heavily from the International Monetary Fund (IMF) without repaying its debts.

Tell me about it! For those who don't know the consequences of said actions I recommend you reference How the US Has Perfected the Use of Economic Imperialism Through the European Union!

"In the end the populace is going to say we didn't go into the euro for this," the Schroders fund manager said.

Fernando de la Rúa, then president of Argentina, had to flee the country in a helicopter after the unrest grew. While the political situation in Greece and Portugal is not yet that serious, there have been widespread protests on the streets of Athensagainst austerity measures demanded by the ECB and IMF as part of a second bailout of Greece. 

It may be even more difficult for Greece and the banks supporting it to recover from its economic problems than it was for Argentina and Brazil, according to Brough.

"If you look back then, we didn't have the transparency we do now, so all the banks that were funding Latin America could smooth over what was going on," he said. "Now, everyone is in the spotlight so it's much harder for banks to smooth it over."

"The middle class in Argentina couldn't just withdraw their money, whereas the middle class in Greece or Portugal can take it out and buy anything that isn't the euro," Brough added.

In Argentina, the government slapped a $250 a week limit on withdrawals from its banks to halt massive pulling out of savings.

I would be remiss in failing to mention that we made this comparison in explicit detail this time last year - A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina.

The IMF estimated the average haircut (decline in the net present value of the bond) was on an average 75% and the market priced in most of this haircut before the actual restructuring in Feb 2005. The prices of the bond in default declined nearly 65% between Feb 2001 and Feb 2005.

One should keep these figures in mind, for in the blog post "How Greece Killed Its Own Banks!"I ran through a much, much more optimistic scenario that wiped out ALL of the equity of the big Greek banks. Remember, the Greek government stuffed these banks to the gills with Greek bonds in order to created the perception of a market for them. As excerpeted...

Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…

image001

The same hypothetical leveraged positions expressed as a percentage gain or loss…

image003

When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:

• • Sovereign Contagion Model - Retail (961.43 kB 2010-05-04 12:32:46)
  • Sovereign Contagion Model - Pro & Institutional
• Euro Bank Soveregn Debt Exposure Final -Retail
  • Euro Bank Soveregn Debt Exposure Final - Pro & Institutional
• Sovereign Debt Exposure of European Insurers and Reinsurers (Empty 2010-05-19 01:56:52)

To date, my work both free and particularly the subscription work, has shown significant returns. I am quite confident that the thesis behind the Pan-European Sovereign Debt Crisis research is still quite valid and has a very long run ahead of it.  Let’s look at one of the main Greek bank shorts that we went bearish on in January:

nbg since research

NBG since research

Now, referencing the bond price charts below as well as the spreadsheet data containing sovereign debt restructuring in Argentina, we get...

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.

Earlier this morning I stated Structural Problems Cannot Be Solved Though Bailouts! As A Matter Of Fact, Bailouts Make The Situation Worse in reference to the situation surrounding Portugal's downgrade to junk status and its inevitable default (in some form or fashion, most likely draped in the political nomenclature of something considerably more palatable to the sheeple). Well, the same goes for Greece, although to a much more drastic extent.

Bloomberg reports: Portugal Rating Cut on Possible Greek Follow

Europe is now inching toward a goal of getting banks to roll over 30 billion euros of Greek bonds, instead of opening a hole for the official lenders to fill. French banks, with the biggest holdings in Greece, worked out a rollover formula that is serving as an example elsewhere, with two options for bondholders to replace their maturing securities.

At the same time, Standard & Poor’s said this week the plan may temporarily place Greece in “selective default” if implemented.

Portugal this year joined Ireland and Greece in turning to the EU and the International Monetary Fund for emergency funding after their budget deficits ballooned. Moody’s yesterday said it also based its credit rating cut on risks that Portugal won’t be able to fully achieve its deficit-reduction target.

“It’s a reminder that the sovereign debt crisis does not end with Greece and that risks remain with other nations in addition to Greece,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York.

I'd like to make this perfectly clear and have absolutely no problem going on the record with it in full HD fidelity...

image002

There has been a large amount of capital lent to (and invested in) Greece. The collateral behind (recipient of) said capital has devalued along with popping of the asset securitization crisis bubble to such an extet that it is a mere fraction of what it was valued at when said capital was invested. What does this mean? Well, it means that no matter what financial engineering scheme you attempt to wrap around it (and I happen to be particularly skilled at financial engineering, so I should know), no matter what socio-political finanacial nomenclature you attempt to drape it in, and not matter how far you attempt to kick said can down the road in a "delay and pray" tactic of pushing the inevitable collapse past your particular tenure at the helm in an attempt to make it someone else's problem... The only way out of this for Greece, Portugal, Ireland and other profligate states is an old fashioned reneging on its payback oblications. A plain vanilla default. The explicit action that unequivocally informs you in no uncertain terms - You ain't gettin' your money back!

The chart above is an obvious reason why Greece not only has an inevitable default in its future, but why the faster they default the better off Greece is as a whole. Reference the test case known as Iceland whose banks defaulte on $85 billion, from Bloomberg:

Debt Raters Miss Iceland Rebound

The credit rating companies that were too slow in predicting Iceland’s economic collapse in 2008 may be underestimating the strength of its resurrection.

Fitch Ratings said in May it may take two years for the island to shed its junk status, while Moody’s Investors Service and Standard & Poor’s give Iceland their lowest investment grades. That hasn’t deterred investors from trying to buy twice the amount offered in last month’s $1 billion bond sale as the island returned to global capital markets less than three years after its banks defaulted on $85 billion in debt.

“When you look at how successful that auction was, it’s clear that investors are now crunching the numbers themselves and that the credit grades from the rating agencies are less relevant,” Valdimar Armann, an economist at Reykjavik-based asset manager Gamma, said in a July 4 interview.

Iceland’s experience shows the rating companies may be overcompensating after failing to identify some of the risks that led to the global financial crisis, said Armann. While Moody’s kept a Aaa rating on Iceland until five months before its banks collapsed, reluctance to raise the island’s credit grade now is blocking the country’s access to a broader investor base. Debt derivatives show the low ratings may be unwarranted as credit default swaps on Iceland indicate it’s less likely to default than euro member Spain.

You see, the only true workable solution is to expunge the debt and have the original debt investors take realize their significant and material capital losses. As it stands now, for political reasons and to maintain the status quo of the existing banking oligarhcy, more debt is being piled onto these nations for the tax paying populace to attempt (and fail) to service! Thus, severe and aggressive austerity plans are being implemented to payback banks and other lenders (at what can be considered usurious terms, enter the IMF), thuse forcing recessionary pressures upon the working populace. This is a thick and heavy shaft, one that is onerous enough to quite possibly require grease for the citizens and denizens of Greece to consider palatable. On the other hand, they can do the Iceland, who is already lapping Greece in both economic growth and demand for its debt!

The situation between the 1st and 2nd Greek (and soon to be Portuguese) bailouts have essentially remained unchanged!

image018

As excerpted from It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking Crisis

If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…

Despite the fact that the only way out of this is a true default and destruction of the debt capital proffered during profligate times, TPTB will try their best to find a workaround, because what's best for the people of Greece, Portugal, Ireland and as we have already seen - Iceland, is absolute anathema to the bankers that binged on this stuff at 40x leverage ans sitting on 50% devaluations as we speak. You simply do the math: 40 x (-50%) = what kind of returns? Insolvency, first and foremost!

Subscription Document Archive:

Greece Public Finances Projections

Sovereign Contagion Model - Retail (961.43 kB 2010-05-04 12:32:46)

Sovereign Contagion Model - Pro & Institutional

Online Spreadsheets (professional and institutional subscribers only)

• Greek Default Restructuring Scenario Analysis
• Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• Portugal's Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy - Professional Analysis

This is a contributing European CDS trader's commentary on the BoomBustBlog research piece "Is Another Banking Crisis Inevitable?".

Note that this opinion was written before the rating agency vs. ECB/EU soap opera of this past weekend which essetially proves what we presented to our pro subscribers early last year - a zero coupon rollup created to restrucuture debt is..... a default! Reference Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts and What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates - both written over a year ago, and both quite prescient. In the meantime, enjoy this guests contribution, annotated as usual by yours truly!

At this stage i have a remark/question in your « the inevitability of a banking crisis »(dated when?) you were waaay too optimistic (!!) seeing 172bn of losses related to PIIGS. We may be over that only on Greece exposure!

Certainly, if we compare the fiscal trajectory of the Eurozone as a whole with the US, the US is not really on a better path. Austerity has started in Europe. US seems still in full spending spree.

I would argue as long as there is no bank run and voluntary secession, things even if shaky, will stay more on less under control by governments. Being anti-Euro can win elections, and there is a real chance that some country (Greece, Finland...) quit the Euro by themselves for not wanting austerity or not wanting to bail out other countries. But so far, its just talk. In Portugal they voted out the PM, well they still got austerity...Ireland is a total joke as well.

So if we step back, and ask ourselves who's going to buy this ever growing govt debt, well this is the banks of course !

Look (I didnt!) at the balance sheet of Japanese banks 20 years ago and now, many JGBs in their balance sheet, in place of those turned sour (real estate) loans...every $ or euro spent from the budget, ends up in a bank account, and the ALM officer of that bank, well, the only stuff he can buy with it, is a govt bond as its the only « safe » asset (what else would be ? Even if they bought all those google bonds...)

Well, if you take a look at how well that technique turned out for the Japanese banks, a widespread, long term bear trade on the banks may not be that bad an idea, despite how obvious the trade may be!

.. It is the reporting company’s responsibility to report, not to obfuscate. The big problem with this “hide the market marks” thing is that markets tend to revert to mean. Unless said market values fundamentally catch up with said market prices, you will get a snapback. That is what is happening in residential real estate now. That is what happened in Japan over the last 21 years!!! That’s right, it wasn’t a lost decade in Japan, it was a lost 2.1 decades!

Now, for those of you who believe that the government's "pretend and extend" policy has any chance in hell of working, or better yet, that we are not following in the footsteps of Japan, let's take a pictorial trip through recent history. There are nearly no Japanese banks in the top 20 bank category on a global basis by 2003 – NONE (save potentially Nomura, which arguably survived in name, alone). As you can see, they literally dominated 90% of the space in 1990!

Click to enlarge…

top_20_banks.jpg

Source: Cap Gemini Banking M&A

... and well if the ALM officer doesnt buy those bonds, and buys something else, the money just ends up in another bank which will buy those bonds !

The system is full circle...there is no flaw as long as people keep their money in the bank.

Hmm, I'ver heard this argument before. This is not just a European perspective. Many in the states believe this is doable a well, reference FASB Appears to Have Bent Over For The Final Time & Accuracy In Financial Reporting Dies An Ignominious Death!!!More importantly, let's explore this full circle theory as exerpted from Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!

As excerpted from Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!, Bernanke et. al. have snipped the chrysalis of the US markets and economy one too many times. He has interrupted the circle of life...

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the “Peak” phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality…

The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. All four corners of the globe are currently “hobbling along on one leg”, under the pretense of a “global recovery”.

In the worst case, banks leave their money in the Central bank which will underwrite bonds.

Thats also why Greek bonds being eligible to the ECB is a key political issue. As long as they are, the ECB can provide money against those bonds... Govts havent printed money directly so far (if they did, no more need to issue bonds, just issue money with no interest...), just bonds that can be repo-ed to the CB and thats really when money is created.

Right on point, as reported by ZeroHedge over the weekend: As ECB Finds Rating Agencies Have Suddenly Found Religion, It Prepares To Flip Flop On Accepting Greek Bond Collateral

Doomsayers have been saying for 10-15 years that the Japanese financial  system would collapse, well the game is still on, and could last another 10-15 years (or more, or less, i dont know !). To me its really a game of confidence. Indeed, if there was a real Greek default and bank runs, then it would sure have a strong impact on the public, and we could have a chain reaction, and thats what i think the European politicians want to avoid #1. cause if they can, the zombified financial system can muddle through for years.

Yes, but as you can see from the charts and graphs above, the kick the can methodology or reality rendering didn't necessary work that well for real asset pricing or Japanese bank global presence, valuation or competitiveness.

So where does this leave valuations and the European banking system ?

Well, on one hand we have this insolvent system, that tries to survive. But there are institutions too weak to be saved.

Bank of Ireland, RBS, … show the way... well end up having more and more govt participation and regulation. In some countries, the whole financial sector might end up being nationalized. Financial sector is dead. It used to be 10%-15% of the equity market capitalization, went up to nearly 40%-45%. on that metric alone, there is much room for downside (perhaps another 50% with the same level in the broad index). Basel III, even if its not enforced yet (and perhaps by the time it should there wont be many private banks left in Europe...), gives a clear message: banks need to raise a lot of equity. And that needs a discount as many banks need this money, the new business model will be less profitable because of less leverage. Banks will try to hike fees, and merge to save costs.

Maybe if we see some spectacular failures, we will see a big transformation, especially with new entrants focusing just on deposits and payments. In Europe, banks are « universal » you tend have your account, your credit card your mortgage, your car loan, your brokerage account with the same institution. In my opinion it would make a lot of sense for Carrefour (for example) to open a banking operation.

Or enter Glass-Steagal - Euro edition!!!

Because of this increase for competition and diminished returns (less demand for loans)... the only « business » which will be growing in banks, will probably, their ALM !! Where they will buy more and more govt bonds (and BASEL III makes sure their risk weightings are 0% and that they have to do so for their « liquidity coverage ratios » (LCR) so they favour those bonds. This will push yields down, and bank profits down as they have to buy more and more of those bonds to try to keep the same profits. EFSF or any kind of Euro bond would definitely be bought with no problem.

And here we go again! What happens when assets held as risk free (zero risk captial weighting) at 30x to 60x levereage are truly nothing of the sort. This exacly how a tiny economic entity such as Greece (whose economy is probably smaller than that of Brooklyn, and definitely smaller than that of the NY metro area) has managed to gut the entire banking system of a plethora of 17 separate countries and much of the continent. Reference:

1. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!

2. Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe

3. and finally How Greece Killed Its Own Banks!

With govt yield downs the extend and pretend game can last for many more years.

That wouldnt prevent banking stocks to go further downhill, as it was the case in Japan, but it might not be a one-way street, and peripheral banks are not necessarily the ones who would suffer most from here in the long run (after all if the crisis is resolved, their underwater govt bonds will be reboosted). And both you and I know that banks know how to twist and inflate their accounting, and that theyre showing profits on what really are losses...

No!!!!! Say it ain't so!

Perhaps another nice short would be the insurance industry.

Been there, done that - Sovereign debt exposure of Insurers and Reinsurers

They might be hurt even more than banks, especially life insurers... especially it has benefited (in France) of a lot of tax rebates / subsidies, which enticed the public into it, and if there is a sovereign accident, I can smell a run there. (I myself cancelled my life insurance, and all the « smart » people around me did so as well.)

All in all, I think it was a great call so far to foresee the European debt mess. But I think its much more tricky for here to make bets. Even the EURUSD trade which looked as a no-brainer at the start of 2011 given how dire the situation was, proved to be much of a pain...( to be honest, I lost myself quite a lot on that one). that should be a warning signal to me that things arent that simple.

As I got gaffed on the artificial bank runup of 2009/2010. You see, the fundamentals have been marred by central planning of the markets on a global basis. Again, I request you reference Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!

Click here for relevant BoomBustBlog European Research from last year and here for current European opinion.

In continuing the discussion of trade setups and related strategies started with As Requested By Our Constituency: Trade Setups Based on BoomBustBlog Research, and continued in …

• More On Trading with BoomBustBlog Research;

• A Conversation Between a CDS Trader and an Equity Strategist,

I bring you the next installation in the discussion of trading the Pan-European Sovereign Debt Crisis. The annotated email chain is actually quite long so it will be continuously broken up. I will also include the comments of the European equity trader in later posts. Any accomplished tradeer who wishes to join the crowdsourced debate is more than welcome to throw their hat into the ring.

Eurocalypse, the European CDS trader

At this stage i have a remark/question in your « the inevitability of a banking crisis »(dated when ?) you were waaay too optimistic (!!) seeing 172bn of losses related to PIIGS. We may be over that only on Greece exposure!

Reggie Middleton, the American Realist

For those that don't read me regularly, Eurocalypse is referring to my work below...

Is Another Banking Crisis Inevitable?

Attention subscribers: A new subscription document is ready for download The Inevitability of Another Bank Crisis

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

Impact of bank’s banking books on haircuts

EU banking book sovereign exposures are about five times larger than trading book. The table below gives sovereign exposure of major European countries for both trading and banking book. The EU trading book has €335bn of exposure while banking book has €1.7t exposure towards sovereign defaults. EU stress test estimated total write-down’s of €26bn as it only considered banks trading portfolio. This equated to implied haircut of 7.9% on trading portfolio with losses equating to 2.4% of Tier 1 capital. However, if the same haircuts (7.9% weighted average haircut) are applied to banking book then the loss would amount to €153bn equating to 13.8% of Tier 1 capital.

We have also presented an alternative scenario since we believe that EU stress test had failed not only to include banks HTM books but also the loss estimates were highly optimistic, as has much of the economic and financial forecasting that has come from the EU. It is highly recommended that readers review Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for a detailed view of a long pattern of unrealistically optimistic forecasting. Here's and example...

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Revisions-R-US!

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In an alternative scenario, we have assumed weighted average haircut of 10% (exposure, haircut assumptions and writedowns for individual countries are presented in detail in the tables below) and have applied writedowns on both banking and trading books with the results available in the subscription document The Inevitability of Another Bank Crisis? Individual and more explicit haircut calculations are available for the following nations for professional and institutional subscribers:

• Greek Default Restructuring Scenario Analysis
• Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
• The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers
• Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts

Eurocalypse, the European CDS trader

Certainly, if we compare the fiscal trajectory of the Eurozone as a whole with the US, the US is not really on a better path. Austerity has started in Europe. US seems still in full spending spree.

Reggie Middleton, the American Realist

I disagree, in a way. The US situation is truly FUBAR, indeed, but it is a slightly differently  FUBAR'd than the EU. The US still:

1. is the world's reserve currency,
2. has the world's pre-eminent military and technological forces (which go hand-in-hand with number 1, hence is essentially the same thing if history is any indicator),
3. has a much more contiguos economy than the EU,
4. although is prone to lie about its book keeping situation, is definitely not as detached from reality as the EU states. Reference:
5. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!,

6. Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Believe Any Others

7. LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

Then there is the commercial real estate issue looming in the EU. The two strongest economies in the EU are being looked to pull the rest of the EU out of the fire through bailouts, but the ugly truth is that they are tied to the proflicate (and not so profligate, but still hampered) states by the waist. Outside of the (borderline recessionary) EU being their major trading partner(s), they have pretty much bankrolled CRE lending throughout the entire trading block. Those loans are due to be rolled over, and they are due to be rolled over on property that has materially declined in value - leaving a significant equity gap. We're talking close to 70% to 80% of CRE loans coming due in the next year and a half on properties that have significant oversupply, weakening rents, recesionary economies, sovereign debt issues and staunch austerity plans, and generally devalued properties leaving many a loan underwater. Haircuts, anyone? Inflation Misconceptions Hide A Downright U-G-L-Y Real Estate Landscape! - Part 1

You see, there is a highly reflexive relationship between overvalued sovereign debt held on a higly leveraged basis on EU bank balance sheets and CRE loans coming due on devalued and underwater real estate. The sovereign debt crisis is straining lending capacity at the same time that excess lending capacity is needed to fund underwater property loans that need to be rolled over. No one is discussing the real estate portion of the EU banking crisis to be, but it is very real!

I have delved deeply into this topic during my lectures in Amsterdam. Reference my featured article in Property EU, one of Europes leading real estate publicatios

Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.

Now, the US is in a similar situation, but we have managed to fudge the books to such an extent that some of our CRE investors have actually risen in price. See The Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression", Why Are REIT Shares Still So High and Which Ones to Short?

With the dearth of synthetic profit streams to support accounting earnings (as banks did in their supposed recover of 2009/10), Weakening Revenue Streams in US Banks Will Make Them More Susceptible To Contingent Risks. I believe, due to major policy errors in dealing with our crash, that we will see our own lost decade(s) in the US...

There are those who believe US CRE is on a bullish trend, but I believe they have been mislead by accounting and regulatory shenanigans. Commercial real estate rarely thrives in high unemployment, increasing interest rates, stagflationary, sluggish economic times. Then again, maybe I'm wrong... Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate

 

The US CRE situation is overshadowed (and possibly rightfully so) by the popular realization that Reggie was accurate in his 2007 assertions that we are in a residential real estate depression, further complicating any truly organica economic recovery - at least until true price discovery is allowed by the financial markets central planning cartel of government and central bankers. Reference:

1. Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!!

2. The "American Realist" Says: Past as Prologue - Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!!

3. The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression! The MSM is Just Catching Up

4. There's Stinky Gas Inside Of This Mini-Housing Bubble, You Don't Want To Be Around When It Pops!

5. Bubble, Bubble, Real Estate Toil and Trouble: Macro Climate for Real Estate Still Sucks, Despite New Bubbles

As this discussion/debate is getting rather lengthy, it will be continued in a later post. In the meantime, interested readers can follow me on twitter or subscribe to BoomBustBlog directly.

This is a conversation I am having, via email, with a European CDS trader that will be posting trade setups on BoomBustBlog based upon my proprietary subscriber research. If you recall his background fromthe post As Requested By Our Constituency: Trade Setups and Examples Based on BoomBustBlog Research Designed to Capitalize on the Coming Eurocalypse:

As I said I have traded mostly on the fixed income markets. What I mean by that is:

• • government bonds, euro-area, (or before it existed, peseta, lira, french franc,...), Sweden, Denmark, UK, US, Japan
  • short term interest futures in those markets  Euribor, Euro$ etc...
• bond futures & options in those markets (tnotes, gilts, bunds, btps, jgb.
  • swaptions & caps & floors
• inflation linked securities (US TIPS, Euro-CPI linked, etc.
  • G7 FX & options

In my best years, I managed more than 10 billion euros equivalent of bonds (and the corresponding derivatives). I was doing 'proprietary' trading, in contrast with 'flow trading" - flow trading is quoting to clients (pension funds, banks, insurers, hedge funds...), and basically stuffing and frontrunning them - or in contrast with exotic derivatives book where you stuff the client selling complex products he doesn't understand and he cannot price by himself ;-)

On average, I made for the firm more than 30M euros a year. Return on asset not that big! Those were the years where you had to be leveraged to make money due to low vol!  I was doing mostly "relative value", picking pennies with "hedged" strategies. So not a big trader like Brevan Howard and co, but I was not in the minor league either. I must say im quite proud of having stuffed a few times the likes of GS, JPM, DB and co.... I also ran the asset-liability department of a French bank so I saw also the other side of the business with all the accounting shenanigans, and I know how banking CEOs run their company...

Here is part one of our email exchange (annotated to add relevant blog content)...

Dear Reggie

Thanks for sending all the material. Im quite surprised at the quality of the material, which I would put largely on par or better than industry produced stuff, and at the time your analysis were written, you were certainly in the most aggressive camp, and the first to give figures with full explanations.

However the material is dated and news abound, and all this crisis has hit the tapes (as you predicted) and became mainstream, with daily articles in the press and blogosphere.

I purposely sent him some relevant material from last year to demsonstrate its prescience. Subscribers should reference the mateial from recent quarters for updates, and fresh Euro and US banking analysis is on tap for the upcoming weak.

I would tend to believe that from here, things are more double sided than before, and risk-reward much less interesting than it used to be, because there are now external factors like government intervention which can kick the can, and screw valuations for a long time.

Anyway, its been game over already for many banks:

1. Bank of Ireland's gone from 18 euros to 0.12 euros (= peanuts)!
   
   1. Clearly forcasted ahead of time in our Irish Bank Strategy Note which adequately warned before Irish banks dropped 85% in value. The Ireland public finances projections is also available to all paying members.
2. Bigger banks like SocGen moved from 140+ to 38 hitting 17.5 in 2009.
3. Credit Agricole 36 euros to 10 hitting 6 in 2009
4. BNP went from 90 to 50 after hitting 20 in 2009
5. French CAC40 peaked around 6000 in 2007 to 3850 today hitting 2500 in 2009.
6. so SG and CAI have been divided by 3.5 basically while the CAC has lost 36% « only ». BNP is in line with the CAC.
   1. Clearly delineated ahead of time in our exposure reports Euro Bank Soveregn Debt Exposure Final -Retail or Euro Bank Soveregn Debt Exposure Final – Pro & Institutional
7. BAC used to be 46$, now 10$ after hitting less than 5$ in 2009 while JPM did much better 50$ to 40$ hitting less than 20
   1. [Reggie Comments] Yeah JPM is stubborn, but also digging a hole for itself. See An Independent Look into JP Morgan...

   2. image001.png

      Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

      This public preview is the culmination of several investigative posts that I have made that have led me to look more closely into the big money center banks. It all started with a hunch that JPM wasn't marking their WaMu portfolio acquisition accurately to market prices (see Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful! ), which would very well have rendered them insolvent - particularly if that was the practice for the balance of their portfolio as well (see Re: JP Morgan, when I say insolvent, I really mean insolvent). I then posted the following series, which eventually led to me finally breaking down and performing a full forensic analysis of JP Morgan, instead of piece-mealing it with anecdotal analysis.

      1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
      2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
      3. As the markets climb on top of one big, incestuous pool of concentrated risk...
      4. Any objective review shows that the big banks are simply too big for the safety of this country
      5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?

      You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish. JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb. I discussed JPM on CNBC's Squawk on the Street - 10/19/2010

      I also illustrated the catch 22 that the European banks are in as the Keynote Speaker at the ING Annual Valuation Conference in Amsterdam last April. All should be aware that the US banks wrote most of the CDS on said European names.

Both US and European banking systems stand on the precipice: Re Click, Clack, Click: The Sound of Falling Dominoes Behind The Door of the Eurocalypse! and The Beginning of the End of the Beginning of the Gutting of the Big Banks Has Begun!

Even if the banking system is insolvent, it doesnt mean those stocks are going to go immediately to 0.1 like Bank of Ireland, that’s the problem!

If a major credit event hits (currently brewing in Europe, US, Japan and China), insolvent bank equity will do the same thing that the previous insolvent US bank equity did - even with the Fed's added equity lines. Yes, I know the big white shoe investment bank analysts never say this, but who has been more accurate over time, them or Reggie? From Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? we can find the result of the Fed's backstopping of Lehman's equity during a liquidity run on an insolvent bank during a major credit event and what the allegedly "respected" bank analyists had to say about it versus BoomBustBlog opinion...

Reggie vs Goldman Sachs

Why didn't Wall Street read my post on Lehman being a yellow lying lemon? See "Is Lehman really a lemming in disguise?" and realize that this post was made on February 20th, when Goldman Sachs had a recommended price of about $55 while this blog warned that Lehman may be done for. This very similar to when I warned about the potential demise of Bear Stearns in January, when the rest of the Street had a "buy" at about $130 per share. See Is this the Breaking of the Bear?. ⁷ We all know how both of these stories ended.

Please click the graph to enlarge to print quality size.

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Interesting to note that the Texas Ratio in your note European Bank Sovereign Debt from May2010 was in line with the relative performance of the 3 French bank stocks.

Those who don't subscriber should reference The Anatomy of a Serial European Banking Collapse for a preview...

Whoa!!! A 63 Texas Ratio when losses were half of what they are now????!!! As Americans, and TExans from the S&L Crisis area know, a Texas Ration of 100% generally means no more bank!

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Where would said Texas Ratio madness come from? Why, exposure - of course!

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Though probably other ratios would have worked as well at it is known that Crédit Agricole or SG have bigger funding problems than BNP. BNP also seemingly bought Fortis at what seems distressed prices so far (they make regret it if/when Belgium goes ballistic but thats not for today).

The sector has clearly seen winners and losers, which means stock picking (in retrospect) can produce a lot of alpha but I doubt the sovereign Texas ratio is the only factor at play and that bets should be placed on that only measure.

[Reggie Comment] We have a lot of bank analysis to pick apart opportunities. Texas ratios simply scratch the surface!

I think you will agree with me the sovereign exposure is the stuff banks can’t hide, its so obvious they have to disclose it all.

[Reggie Comment] They can’t explicitly hide it, but they don’t have to because the European regulators, central bankers and politicians are complicit in allowing the banks to declare that these « toxic » assets 1are risk free and to be carrier at par. You don’t have to hide the truth if lying is legal! Very similar to the US situation, although I believe the US has a stronger overall economc potential. That is "potential" not necessarily existing economic activity. Currently, I believe the US consumer to be economically "dead in the water" with many corporate financial statement in tow!

We can see the whole European banking sector destiny is hand in hand with the states finances, their balance sheet being so loaded with the stuff. Having worked in a bank, I can tell there are much worse things to come that’s not even in the financial reports ! Also, regarding the French banking sector, I tend to believe most of the PIIGS exposure is in the less sophisticated players.

Thats why the govts will try to prop up the banks. IMHO an analysis of a contagion effect should include not a sovereign exposure but interbank + sovereign exposure - because of the leverage.

We have attempted such an analysis with the BoomBustBlog Sovereign Contagion model, although this was more of inter-sovereign linkage than a direct interbank linkage.  

The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference  The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance.

If Greece defaults, Greek banks (at the very least) become instantly insolvent, and the Greek depositors would probably be on the hook. Domino effect, thats your scenario.

The Greek banks are insolvent now. There’s really no way around it. They have had multiples of their net equity invested in Greek bonds at 30+x leverage and those bonds have devalued by 50% of more. They haven’t been solvent for some time. If you remember last year when  illustrated How Greece Killed Its Own Banks!, you realize the main reason why the EU has been using the kids gloves with the Greeks. To make a long story short, let’s employ the old adage “A picture is worth a 1,000 words”…

Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…

The same hypothetical leveraged positions expressed as a percentage gain or loss…

Add to this the reports of incessant runs on deposits at Greek banks as depositors (wisely) move their funds to safer horizons, consequently increasing the implicit leverage upon which said Greek banks operate and eliminating any cushions provided by ECB bailout!

Who would want to leave his money in a Portuguese bank and so on, if depositors lose their money... Bank runs, the system would collapse quickly. By the way, in that doom scenario, i can't see how even US or Japanese banks can go unscathed through their interbank lending and derivatives operations.

But lets say ok, were going to have those 50haircuts on the PIIGS. According to your figures, thats a 2 trillion (50% of 4 trillion ) problem. Well we've seen trillion bailouts in the US, we can certainly do it in Europe. And also as its governement debt, there is still plenty of power to tax. All forms of taxes going up everywhere is the 100% safe bet.  Loss of liberty for citizens seems also the trend.

I will continue this conversation, as well as at least one other, later on in the day. In the mean time...

Online Spreadsheets (professional and institutional subscribers only)

• Greek Default Restructuring Scenario Analysis
• Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
• The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers
• Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
• This is the professional addendum to the  Sovereign Debt Exposure of European Insurers and Reinsurers (439.61 kB 2010-05-19 01:56:52) can be found online here: Insurer and Reinsurer Sovereign Debt Exposure Worksheets – Professional

If readers remember back in 2009 I warned of the excessive risk of mortgage buybacks in the banking industry. Many analysts dismissed this risk then and still do (at least as recentely as the 1st quarter).Yes, I know my wording can be a tad,,, "bombastic", but that does not detract from the validity of said words. Let's parse recent history, shall we?

The Putback Parade Cometh: Pimco, New York Fed Said to Seek Bank of America Repurchase of Mortgages

You've Been Had! You've Been Took! Hoodwinked! Bamboozled! Led Astray! Run Amok! This Is What They Do!

As far back as 2009  (yes, over a year ago) I have been warning readers and subscribers of the (not so) hidden risks of putbacks, warranty and rep reserves, and the overly optimistic under reserving of the big commercial banks. I used JP Morgan as an example (see link list below), but made it clear this warning stood for several big banks(several of the big banks – As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves, As a matter of fact I said that the banks ‘May Become The “New” Tobacco Companies‘ due to legal risk. This risk was significantly exacerbated the day after making that post, Less Than 24 Hours After My Warning Of Extensive Legal Risk In The Banking Industry, The Massachusetts Supreme Court Drops THE BOMB! wherein the Massachusetts Land Court Decision that invalidates foreclosures based on post sale assignments was up held by the Massachusetts Supreme Court. This is permanent, and precedent setting, absolutely justifying and vindicating my post from the day before and clearly demonstrates that The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!

The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!

Step one: Hide the Truth!

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JP Morgan Purposely Downplayed Litigation Risk That Spiked 5,000% Last Year & Is Still Severely Under Reserved By Over $4 Billion!!! Shareholder Lawyers Should Be Scrambling Now

See As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves or “After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????” As excerpted from the The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!

This is the part that everybody seems to be overlooking…

All you really need to do is find the banks that accepted a lot of broker business, factor in the expense of the class action suit litigation that is popping up in nearly every state (try Googling it, you will be amazed as big firms and store front lawyers alike are throwing their hats in the ring), and you will see the easiest way out of a potentially tough bind for investors is the put back. Where does this land? Squarely on the balance sheet of the banks – who, BTW have the money to attract even more predatory lawyers. A forensic review of high LTV loans between 2003 and 2007 should find that at the very least 30% were aggressively valued, with a more realistic number coming in at about 60%. Ask anyone who was in in the business at that time, I doubt they will disagree.

When I warned of this LAST YEAR, it was not taken very seriously. I suggest all should think again – Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results. Let’s reminisce…

• Re: B of A - With Banks Being Forced To Admit The Inevitable Truth, How Long Will It Be Before Fundamentals Rule The Day Again?

• As JP Morgan & Other Banks Legal Costs Spike, Many Should Ask If It Was Not Obvious Years Ago That This Industry May Become The "New" Tobacco Companies

• I Warned That Banks Will Soon Be Forced To Walk Away From Homes... Guess What!

• and much more:Dexia Sets A $5.1bn Provision For Loss On Trying To Sell The Same Residential Real Estate Assets Upon Which JP Morgan Has Slashed Provisions 83% to $1.2bn from $7.0bn or There's Something Fishy at the House of Morgan

By now I can assume you either catch my drift or never will. If you do catch said drift, realize that the WSJ reports:

BofA Nears Huge Settlement

Bank of America Corp. is close to an agreement to pay $8.5 billion to settle claims by a group of high-profile investors who lost money on mortgage-backed securities purchased before the U.S. housing collapse, said people familiar with the matter. The payment would be the largest such settlement by a financial-services firm to date, exceeding the total profits of the Charlotte, N.C., bank since the onset of the financial crisis in 2008. Bank of America's board approved the settlement during a meeting Tuesday to discuss the matter, one of these people said.

... A settlement would end a nine-month fight with a group of 22 investors who hold mortgage-backed securities originally valued at $105 billion, including the giant money manager BlackRock Inc., the insurer MetLife Inc. and the Federal Reserve Bank of New York.

A deal could embolden mutual-fund managers, insurance companies and investment partnerships to seek similar settlements with other major U.S. banks by arguing that billions of dollars in loans they bought before the housing collapse didn't meet sellers' promises or were improperly managed. Bank of America, Wells Fargo & Co and J.P. Morgan Chase & Co. collect loan payments on about half of all outstanding U.S. mortgages.

The dispute between Bank of America and the mortgage investors began last fall when they alleged in a letter to the bank that securities they scooped up before the financial crisis from Countrywide Financial Corp. were full of loans that didn't meet sellers' promises about the quality of the borrowers or the collateral. The investors also alleged Countrywide failed to maintain accurate files while managing the loans. Bank of America purchased Countrywide in 2008 for $4 billion.

... Bank of America would take a corresponding pre-tax charge against earnings for the second quarter, these people said. The after-tax cost to the bank would be roughly $5 billion, they said. The charge would increase the chances that Bank of America will report a loss in the second quarter.

...On Wednesday, the bank is expected to announce it is taking a separate provision of billions of dollars during the quarter to cover future repurchase claims and other mortgage-related issues, these people said. The trustee expects to submit a filing soon asking a New York state court to approve the transaction.

...Earlier this year, the bank said its maximum possible loss from private mortgage put-back demands was $7 billion to $10 billion—above and beyond the $6.2 billion already reserved for probable mortgage-repurchase losses.

A multibillion-dollar charge would "wipe out most earnings in the first half of the year," said banking analyst Mike Mayo earlier this month, before news of the potential settlement. Bank of America earned $2 billion in the first quarter. Mr. Mayo had lowered his 2011 earnings-per-share estimate to 50 cents, from $1, based on an expectation that a settlement could amount to $7 billion.

I urge all readers to look back through your sell side analysts notes and ascertain whether these putback risks were adequatliy delineated back in 2009, like they should have been. As the WSJ article stated, "A deal could embolden mutual-fund managers, insurance companies and investment partnerships to seek similar settlements with other major U.S. banks by arguing that billions of dollars in loans they bought before the housing collapse didn't meet sellers' promises or were improperly managed. Bank of America, Wells Fargo & Co and J.P. Morgan Chase & Co. collect loan payments on about half of all outstanding U.S. mortgages.". Oh, this is guaranteed. The insolvent monoline industry (the very same industry whose leaders - Ambac and MBIA - we declared insolvent in 2007) has been at the forefront of the putback brigade, and for good reason.

For the record, from Amercian Banker:The deal could set the stage for settlements by the other big banks sued for mortgage securities losses — JPMorgan Chase, Citigroup and Wells Fargo. Paul Miller of FBR Capital Markets estimated B of A's total losses from soured mortgages could reach $25 billion. Miller predicted Chase's losses could reach $11.2 billion, Wells Fargo could lose up to $5.2 billion, and Citigroup could see losses of at least $3.3 billion. Before reports of B of A's settlement came out on Tuesday, FDIC Chairman Sheila Bair said, "Unresolved legal claims [related to these mortgages] could serve as a drag on the recovery of the housing market." The Journal added the $8.5 billion is more than "the total profits of the Charlotte, N.C., bank since the onset of the financial crisis in 2008." Wall Street Journal, New York Times, Washington Post

BoomBustBloggin'

Relevant BoomBustBlog Research

For public consumption: An Independent Look into JP Morgan

Subscriber ony:

JPM Q1 2011 Review & Analysis

JPM 3Q 2010 Forensic Update

 Federal Reserve MBS Purchasing Analysis (1.96 MB 2010-12-15 13:10:09)

 BAC Q1 2010 Earnings Review (272.63 kB 2010-04-21 11:32:13)

 Bank Charge-offs and Recoveries 2Q10 (272 kB 2010-10-01 12:06:03)

Summary: Hey Mr. & Mrs. investment committee members, here's a strong investment idea. Let's take 30% of our money off of the table after losing 48% of it already, and reinvest 70% of it back into the original investment pool, but this time accept 20% in equity risk just as the country we're investing in is about to undergo a nasty, self-imposed austerity driven recession while our new fixed income position is subordinated in real time by the IMF, and soon likely to trade underwater just about as quickly. Now, where's my damn bonus??? I have an appointment with the Azimut dealer!

As outlined in explicit detail last week in the post The Anatomy of a Serial European Banking Collapse, French banks (and by extension, France itself) risk outright financial collapse if the Greek situtation progresses in its current direction. Of course, armed with said knowledge, there is no surprise that the French are the first to blink. From CNBC: Sarkozy Confirms Greek Debt Deal With French Banks:

French banks, among the most exposed to the Greek debt crisis, have reached an outline agreement to roll over holdings of maturing Greek bonds, part of a wider European plan to avoid sovereign default.

Immediately after French President Nicolas Sarkozy announced the breakthrough, German bankers voiced their interest in the "French model."

Of course they are, because right after the French, the Germans are next in line for the capital gutting experience of this generation as a result of binging on profligate debt. As a matter of fact, the German banks will most likely be very open to the ideas that Ireland may be floating right about now - and Ireland's goverment will probably push a harder bargani than Greece's.

image004

The news came as international bankers met euro zone policymakers in Rome to discuss how the private sector can share the burden of a second rescue programme for Greece. 

Sarkozy told a Paris news conference that French banks would be offered 30-year Greek bonds with a coupon equivalent to the euro zone's lending rate to Athens, plus a premium based on Greece's future economic growth rate.

European Union leaders agreed last week that extra public financing to help Greece avoid bankrupcty would depend on the voluntary involvement of private sector bondholders in a way that did not cause a "credit event" and that credit ratings agencies did not brand as a selective default.

A French banking source said on Sunday the French Treasury had reached a deal with banks to make a rollover more palatable to creditors, who would reinvest 70 percent of maturing debt in the 30-year Greek bonds, of which 20 percent would go into a zero-coupon guaranteed bond based on high-growth stocks.

Whoa! That's a mouthful (figuratively andl literally). Let's see here... The lenders will reinvest 70% of maturing debt, which will allow them to derisk 30% of the current investment and get it back. But if the Greek bonds are currently trading at 50 cents or so on the dollar and the Greeks don't have the money to make good on the maturing bonds, then the investors are basically buying calls on the 70% they are leaving on the table. Those calls are coming in the form of a rather structured investment in and of itself- "who would reinvest 70 percent of maturing debt in the 30-year Greek bonds, of which 20 percent would go into a zero-coupon guaranteed bond based on high-growth stocks."

The risk on new long maturity bonds that still have signfiicant default risk may very well be worse than taking your medicine right now and calling it a day. Remember, an IMF bailout (3rd or so, but who keeps count anymore) is part and parcel to this deal. Everytime the IMF steps in, they issue payday loan terms (you know, like in the US urban ghettos and housing projects), except unlike the pay day loan sharks guys who simply take two pound of flesh and allow you to waste the balance of your paycheck accordingly, the IMF takes 3 pounds of dermis and then proceeds to instruct you on how and with whom you can engage the balance.

So, if by the 3rd IMF bailout there are still some investors left (and according to this newsflash above, there will still be some - albeit with only 70% of thier skin in the game to be cut off by the IMF) in the case of default the IMF has 3 rounds of subordination that it has forced on existing and new investors. Remember, the IMF gets paid first, unlike the EU/ECB. Since we should all agree that there is naught but faery dust and pixie vapors backing much of these fiat currency based bonds out of Greece (see Greece Reports: "Circular Reasoning Works Because Circular Reasoning Works" - Or - Here Comes That Default!!!), if one were to assume a Lehman style recovery (ex. 6 cents or so on the dollar) and the new bonds end up trading in the same range as the "to be rolled over bonds" (ex. 52 cents or so on the dollar), then the ECB, a mutitude of private banks, pension funds and insurances companies can all get into a drawn out fistfight over those 3 pennies the IMF may let through the net! Reference LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

As illustrated above, there is a higher probability for a Greek sovereign debt restructuring in 2013, which will definitely not hurt IMF (since it has a preferred right) but the Euro Members and other investors who will be holding the Greek debt.

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What is guaranteed to be interesting is what happens if I (and many traders and strategists that I speak to) turn out to be correct and that global equity markets will continue to be on a slide as we pay the piper for the transgressions we failed to address in 2008. Well then, equity and fixed income investments take a big hit - and those new structured Greek bonds mentioned above get sacked, and then defaulted on.

Will the Irish and Portguese follow suit in issuing structured products in lieu of paying their debt in cash? There's nothing like taking 30 cents on the dollar of an invesment gone bad to the tune of 50 cents and investing the balance into an equity markets of an economy that is about to go into a recessionary spiral. Of course, there's still that additional default risk thingy. Can you imagine the losses building up on the ECB's books? 

Bloomberg has a Greek analyst (about 1:40 into the afore-linked video) quoted as saying Greece is expected to get roughly 10 cents on its expected dollar in regards to the privatization asset sales that it is allegedly conducting. We initially broached this topic in the spring of 2010 after illuminating the abject fallacy of Greece forecasting asset sale prices that were greater than the prices of the assets current market price - despite the fact that Greece is widely known to be a distressed seller. Last month, I revisited the topic in Greece Reports: "Circular Reasoning Works Because Circular Reasoning Works" - Or - Here Comes That Default!!!

Greek Reporter (hat tip to ZeroHedge) reports: Government Finalizes Privatization List

The Greek government will proceed with the acceleration of the privatization of state property and companies, setting a target of at least €15bn by 2015. [Reference the highlights of the BoomBustBlog subscription document below.]
The decisions are expected during the week, probably on Wednesday, at the meeting of the Biministerial Committee on Privatization. The government will finalize a list of companies and property for utilization, which will be presented by Prime Minister George Papandreou to the European leaders in Brussels.
Special Secretary for Privatization G. Christodoulakis and bank representatives have been preparing the content of the list at a meeting yesterday.
National Bank and London-based CC&C Advisors LTD have been assigned the task of financial servicing related to planning, monitoring, coordination and implementation of the restructuring and privatization program.
The Committee will have to approve the award of the of the utilization program to the qualified Greek banks, but also to the consultants who will carry each project.

Sources note that consultants for Athens International Airport have already appointed, while the proposed list includes:
• The concession of ports and airports with long-term contracts
• The extension of concession period for Athens International Airport
• The sale of a stake of Public Gas Corporation
• The sale of a 49% stake of Casino Mont Parnes
• The privatization of state lotteries through concessions
• Finding a strategic investor in Hellenic Post
• The sale of a stake of OTE, Hellenic Defense Systems and Larko
• Renewal of OPAP’s licenses
• Licenses for online betting and “slots”
• The concession of Egnatia Odos
• The sale of TRAINOSE
• The sale of state stakes in banks (Hellenic Postbank, ATEbank, Consignment and Loans Fund)
• The privatization of water supply companies (EYDAP, EYATH)

This is a tragic Greek comedy. Professional/institutional subscribers should reference the Greece Public Finances Projections 2010-03-15 11:33:27 694.35 Kb in its entirety. For those who chose not to subscribe, I am posting excerpts from pages 5 and 6 from said document, don't read this while eating or drinking for fear of spitting up your lunch!

Any subscribers who would have went heavily bearish into these banks when I first commented on the would have done quite well:

• • Banks exposed to Central and Eastern Europe
  • Greek Banking Fundamental Tear Sheet

As usual, yours truly,

The wielder of the Fiery Sword of Economic Truth, cutting through investment related Bullshit in a country near you!