The past few
days have been very bad for the world's largest banks. American behemoths
Citigroup and Bank of America are down about 7% each. Across the Atlantic,
things are far worse. BNP Paribas, Barclays, and Banco
Santander are all down 13% or more... and Société
Générale is down an astounding 16%!
Some pundits
warn of an overreaction and suggest this is a buying opportunity for the
beat-up financials. I disagree. Rather, I think the financials should now be
considered toxic assets. Caution is justified.
It was only a
week ago that markets were preoccupied by a downgrade of Portuguese sovereign
debt and renewed concerns that Greece will need about $100 billion by year's end to remain solvent. Now, as eyes are quickly
shifting towards the first tremors of financial crisis in Italy, concerns
over Greece and Portugal seem rather quaint. With an economy roughly 7 times
larger than that of Greece, Italy is simply too big to bail out. Its
collapse, like the sinking of a great ship, could create a vortex that drowns
Europe's major banks in red ink.
In addition
to exposure to sovereign debt from insolvent nations like Greece, Italy,
Spain, and Portugal, major US and EU banks are also massively exposed to
toxic mortgage debts, the value of which continues to be eroded by crumbling
real estate markets across the West. Meanwhile, at the least opportune
moment, the banks are being besieged by ill-targeted regulations devised by
vindictive politicians. Finally, banks' balance sheets are skewed by
ultra-low interest rates and new rules that shield them from pricing their
assets to market. Beneath a thin veneer of smoke and mirrors, serious risks
remain.
Intractable
budget negotiations in Washington and Rome have significantly increased the
likelihood of default by the West's two major economic blocs. It could be
reasonably inferred that we are entering a new phase of sovereign decline:
the US is within weeks of temporary default; Italy is teetering; and the
consensus on Greece is shifting toward the 'German fix' of bondholder
haircuts. What's worse, there are no long-term solutions readily apparent.
The EU is so rigid that it's only option is to break into pieces, while the
US is so pliant that its main political parties are allowed to waste precious
time scoring political points at the expense of the greater good.
Since the EU
does not have a formal mechanism for handling default, large European banks
have been 'persuaded' for many months by the ECB and national governments to
invest in the debt of financially challenged nations within the EU, most
importantly that of Portugal, Ireland, Italy, Greece and Spain (PIIGS). This
approach was considered more politically viable than direct investment by the
ECB. Now, these European banks are left holding the bag. Since there is still
no viable mechanism to deal with this debt at the sovereign level, it's no surprise
that EU banks are being hit hardest in this correction. The question remains:
what were they promised in exchange for 'walking the plank' into the debt
abyss?
American
banks have a lesser exposure to sovereign debt of the European PIIGS, but
many of these institutions have made massive profits by selling insurance
derivatives known as credit default swaps to their European counterparts.
This is the same strategy that brought down insurance behemoth AIG in the
wake of the 2008 Credit Crunch. Therefore, major American banks are far more
heavily exposed to PIIGS debt than first appears. It's as if they have
learned nothing. Even conservative, and supposedly bulletproof, money market
funds have exposure to EU bank debt.
I do not
expect all of these banks' shares to go to zero. Powerful governments are
likely to resort to almost any means to salvage their grotesque
central-banking/fiat-money system. Likely, that will include eventually
forcing their citizens to rescue their banks again -- but this time from even
larger losses. However, in the meantime, the financials' earnings and share
prices could suffer dramatically.
Moreover,
Italy's situation brings some larger questions to the forefront: what happens
when the next round of bank bailouts bring major sovereigns to their knees?
Where will you want to have your assets positioned if the EU comes apart at
the seams, or the US stops paying its soldiers and seniors? What's your plan
if the central banks flood the market with even more cheap money?
Readers are
strongly encouraged not to waste time gambling on shaky financials, but
rather to build themselves an ark of hard assets and start rowing away from
the sinking great ships of state. You don't want to be caught in the vortex
when they go down.
John Browne
Senior Market Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax:
949-863-7100
www.europac.net
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