Friday, 22 June 2012

Bank downgrade - yawn. Europe downhill. Spain

Banks downgrade
Moody’s has been doing a hatchet job on banks across Europe recently and yesterday saw Moody’s downgrade 15 large international banks. For some reason it came as a shock to many. I do not really get the point. The markets have known for years that something was wrong in the banking sector. The banks are forced to increase their capital base, reducing their profitability. Households are deleveraging, reducing income for the banks. So why is it a surprise that banks are a worse business now than before? The chart below compares global banks (blue line) to global equities (red line). Banks have underperformed the market badly – the market participants have been voting with their feet for years.

The “Flash” PMI for the Eurozone and for some of the larger countries were released yesterday. It was very bad reading, as the European contraction continues. The German index showed an accelerating contraction. German export orders continue to fall rapidly. The only question one can ask is how long it is allowed to continue. I wrote on Thursday that domestic and international pressure on Merkel to change her economic policies were mounting. Yesterday’s data release just confirms that economic policies in Europe must change and the sooner the better. IMF Chief Lagarde seized the opportunity to tell the German government that joint debt would be a very useful element in solving the crisis. I remain optimist that they will. Germany will find it in her own interest to adjust. The only question is when.

For a comparison, look at Industrial Production in USA (red line) and in the Euro-zone (blue line). Europe’s output has been falling whereas the US output has been increasing. The difference? The degree of austerity.

Two international consultancies had been asked to conduct an independent review of the capital injection needed to salvage the Spanish banks. They ended up with a maximum of 62bn EUR. Just some months ago the Spanish government believed that 25bn would be enough. Or at least that is what they said. Two weeks ago the same government asked for 100bn in help from the Euro-zone.

I think the 62bn is good news, on the condition that the two consultancies have built in enough buffers in to compensate for the continued recession in Spain that will increase the credit losses. At this moment it is not important if the necessary capital is 62bn or 100bn. We just need to get to a point where the markets finally begin to believe that the number is final. 

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