Stress-testing European banks and then releasing the results is no cure for the euro debt crisis. Investors will be rightfully suspicious that bank regulators and sovereign governments are trying to sell them a bill of goods by setting up tests that banks are sure to pass. Investors were just as suspicious when the United States conducted its own stress tests and then released very incomplete information on which banks had passed.
But conducting the tests and then not releasing the results is a disaster. Then investors have absolutely no information to restrain their imagination. And are left with the very logical question of “Why won’t they release the results?”
Today, June 17, European Union governments dodged that disaster when, at a meeting in Brussels, they decided to disclose how banks did on stress tests.
The European banking industry had violently opposed releasing the results of the tests but the Spanish central bank, the Bank of Spain, had forced a pro-disclosure decision by saying on June 16 that it would release the results of its stress tests on Spanish banks. Failing to follow Spain’s example would have been undercut confidence in exactly those parts of the European banking system—particularly German regional banks—that most worry investors. Germany had been the leading opponent of releasing the results of the tests. (Under German law banks have to approve any public use of their data so it’s not at all clear to me what Germany plans to release. At a guess, I’d expect it to be less than what is released by other Euro Zone members.)
The results of the stress tests will be published in the second half of July. (Hope the crisis is planning on going to the beach until then.)
I expect that in the case of Spain, currently the focus of worry in the Euro Zone, the country’s big banks will come out fine. They may be required to raise new capital, but as in case of stress tests in the United States I expect that their capital requirements will be within their ability to raise money in the markets. I expect that the case will be very different with at least some of Spain’s 45 unlisted savings banks, the cajas. Some, at least, will be so short on capital that the Bank of Spain will be forced to close them or to broker a merger. That, however, seems to be the course that the Bank of Spain has already chosen so that result wouldn’t come as a huge shock. The Spanish Fund for Orderly Bank Restructuring (FROB in its Spanish acronym) has about $15 billion available to use in supporting mergers among the cajas.
That’s a start but probably not enough.
Which raises an important difference between the U.S. and European stress tests. In the United States the U.S. Treasury promised to provide capital to banks that needed it according to the results of the stress tests if they couldn’t raise it in the capital markets. In Europe it’s not at all clear where banks who need capital but that are shut out of the financial markets could go for capital after the test results are released.
German Chancellor Angela Merkel told reporters in Brussels asking just that question that the European Union has “taken precautions.”
I don’t have the foggiest idea what she’s referring to. The $900 billion financial backup plan put together by Euro Zone leaders recently is focused on riding to the aid of sovereign national governments that can’t raise money at a reasonable cost in the financial markets.
It’s wouldn’t seem to be a solution for troubled individual banks. Would they be able to turn to individual central banks—many themselves under stress—or to the European Central Bank?
I’m glad that European leaders have agreed to release the results of bank stress tests, but I sure wish they’d get ahead of this crisis rather than always slapping together solutions at the last minute that just raise questions that they can’t answer.
southof8,
1. Eliminate Fannie and Freddie and every other government program designed to subsidize mortgages (or at least stop them from adding any more mortgages). By doing this, banks will immediately tighten their lending standards, since their money will be on the line. This will immediately cut down on the number of mortgage applications, and the real estate market will drop significantly. While people will lose a lot of equity in their existing homes, new home buyers and low income housing buyers will find it easier to buy into the dirt cheap housing prices.
2. Absolutely! That is one of the single best ways to create inflation. How much inflation would depend on several factors: First, how much do the people spend as opposed to saving? And second, how much money is being handed out in relation to the overall money supply? If you recall when Bush did it, it had very little impact on inflation, because the amount handed out was trivial in comparison to the money supply.
BenWobbles,
DRR has a lower expense ratio.
kelvinator,
I agree that the long term trends are towards inflation in commodities. But the short term trends are closer to deflation. However, the economic reports this week show a VERY slight trend back towards to inflationary side.
Sorry, 2 got cutoff.
2. If the government prints money and hands it out to its citizens via fiscal policy (tax cuts and government spending both operate to put money in the hands of the public, not the banks), does that imact your view on deflation?
Clearly the government is beating people into increasing money velocity by keeping interest rates so low it’s not worth saving it. Banks are hoarding but it’s working on the consumer- savings rate is falling.
Ed, two questions (one related to the housing bubble discussion on the post about CPI numbers):
1. What policy or law can the government enact to deflate the housing bubble?
2.
Ed-
The fallback in key commodity prices like copper, oil and so on clearly reflect the concern about overcapacity vs demand you’re talking about. It seems the markets are pricing in new information and some surprise that the global recovery and growth is less than had been thought or that another downturn is in the works. Still, a medium term investor might say this is just an unimportant short term reaction that won’t amount to much in a year or two. As an investor, if you have a choice of owning real materials growing scarcer by the day that are absolutely vital to the global economy on one hand, and a pile of the literally unlimited amounts of “paper” (electronic blips) governments and the bloated global financial industry are turning out, it becomes a low-brainer to get a grip on the real stuff and go light on the paper promises. A lot of investors see wassup with money printing vs commodities, and I’ll bet most big commodity stocks don’t come near their recent panic lows again. Also, it seems to me the gov’t will become desperate enough to find ways to bypass the banks and inject money directly into the economy if we start heavily into deflation. Checks straight into consumer mailboxes work, as do work programs – they’ve already done some, and they’ll do way more if needed.
Still, for those of us who don’t like our investments to go powerfully negative before they come into the money, timing makes a big difference. I’ve had a big load of energy for years and will keep it, but to get somewhat lower prices on some of the other cyclical commodities.
Ed,
I’m holding large position in EUO, what do you like better with DRR?
DJBarber,
The problem with only looking at the currency aspect of the world economy is that it ignores the overcapacity problem we have (i.e. too much industrial production without enough consumer demand).
While the potential is there for inflation, just printing the money and handing it to a bank which isn’t spending it (or loaning it out) isn’t enough.
This is NOT the time to buy commodities.
off topic currency
“Browder is buying commodities to profit from looming currency crisis”
“He believes that burgeoning debt and budget deficits in Europe and the United States will lead to the debasement of these currencies, shifting economic power to the better-positioned emerging economies.
“The enormous debt burdens and deficits are the elephants in the room. Emerging markets generally don’t have them,” he said, speaking to Reuters at the GAIM International hedge fund conference here.
He said governments had few available options to deal with these problems, since raising taxes or cutting expenditure were politically risky and borrowing money would only worsen the long-term problem
”
http://www.mineweb.com/mineweb/view/mineweb/en/page67?oid=106490&sn=Detail&pid=39
This is one of the reasons why I continue to hold DRR…