Tags: hans | parisis | euro | dollar | risks

European Risks on Vacation, Not Gone for Good

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Thursday, 29 Jul 2010 09:39 AM Current | Bio | Archive

After Federal Reserve Chairman Ben Bernanke said last week that the prospects for the United States were “unusually uncertain,” California Governor Arnold Schwarzenegger yesterday declared a state of emergency in an attempt to tackle the terrifying threat of a $19 billion budget deficit.

State employees are to be sent home without pay for three days a month and IOUs may be given in lieu of cash.

That’s a serious situation, but global investors should not overlook the fact that despite California's problems, their situation is not as bad as the challenges faced by southern euro economies.

Never forget California is in a fiscal union. Tax revenues from New York will bail out the citizens, though not the state of California.

On the contrary, Greece, Spain, Portugal, etc., are left to their own fiscal devices if the eurozone countries, as one coherent block, would be forced to let them down.

It’s certainly not an overstatement to say that both sides of the northern Atlantic are facing serious problems that won’t be resolved quickly. We are talking about many, many years.

Now that there is some optimistic perception of a somewhat stronger euro after the European Union’s bank stress tests seem to reassure, at least for now, some bondholders that lenders in the eurozone can withstand an economic slowdown, it is for sure that only time will tell if that perception is correct.

While the recent stress tests might have helped alleviate concerns about the European banks’ 6 percent Tier 1 capital positions, the key now will become “whether banks will be able to consistently access market funding at terms which allow them to make a meaningful contribution to a fully functioning economy.”

That said, global investors should also ask themselves what could happen when instead of using a 6 percent Tier 1 capital threshold, the Swiss standard of 8 percent Tier 1, as it was applied by the Swiss regulator FINMA on the Swiss banks UBS and Credit Suisse, would have been used.

The failure rate of European financial institutions would have gone up exponentially. Instead of seven banks failing, 39 of Europe's biggest banks would be undercapitalized, and the impaired assets would amount to a whopping 2.6 trillion euros, or $3.4 trillion dollars.

In my opinion, I must say the European Union’s bank stress tests were a farce because the complete lack of taking into account of counterparty risk or a sovereign default.

Nevertheless, the stress tests have provided some good data points that allow the global investor to put 39 banks and financial institutions that would fail under the 8 percent Tier 1 criteria on their radar screen.

The European sovereign risk hasn’t gone away. It’s just on its summer holidays and that will over when autumn comes in September.

In this context, we’ve also learned that the International Swaps and Derivatives Association (ISDA) has received queries by some banks about the impact the potential fallout on the derivatives and bond markets if a European country would be forced to leave the euro.

It is now clear that some banks have started early stage planning to deal with such an event.

For now, it must also be said the moves are still at an early stage and it is still unclear who would be part of the group.

One person close to the process said that because of the sensitivity of the issue, only a small number of members (about 12, predominantly banks but also investors) are concerned.

I can’t rule out the euro continuing to strengthen into the 1.3126-1.3144-1.3240 zone.

In case that happens, shorting the euro further could become more and more interesting.

Of course, everybody has to decide for himself.

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After Federal Reserve Chairman Ben Bernanke said last week that the prospects for the United States were unusually uncertain, California Governor Arnold Schwarzenegger yesterday declared a state of emergency in an attempt to tackle the terrifying threat of a $19 billion...
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2010-39-29
Thursday, 29 Jul 2010 09:39 AM
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