Bussiness News
European Leaders Should Focus on the Banks, Not the Sovereigns
By
Peter Atwater
Nov 30, 2010 10:40 am
Until Europe divorces banking strength from sovereign strength, they will both go down together.
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Over the past year, a consistent pattern has developed in which every country's ratings downgrade (those of Greece, Ireland, Spain, Portugal) has been immediately followed by a downgrading of the country's major banks. Banking strength is only as good as the government strength behind it.
For whatever reason, the markets seemed to ignore this critical linkage, or at least the markets believed that individual government strength was assured by the collective strength of the various stabilization facilities put together by the EU.
For some time I have talked about Europe as a House of Mirrors where "when it works, it works well as the money flows around and around and around 'reflecting' from one country to another. But when one county breaks, the stream of light (money) stops, and given the interconnectedness created by all of the mirrors, the entire house runs the risk of going dark."
What the situation in Ireland reveals is that you can have a well-funded sovereign nation and a banking system liquidity crisis, because well-funded doesn't mean solvent. And CDS spreads make that all too obvious. When it comes to solvency, liquidity is not "confidence" as Fed Governor Warsh would suggest, but rather "anesthesia" that merely dulls the pain for some period of time until the dosage needs to be increased yet again.As Bloomberg notes this morning, the bank run has now extended from Ireland to Portugal. Yet again, credit is a coward and is fleeing uncertainty. Depositors, like bondholders, know that the intertwined European government/bank network needs less, not more debt and that someone is ultimately going to get a haircut. And with Ireland already implementing "burden sharing" and the EU suggesting that the barbershops will clearly open in 2013, there is little incentive to stick around to see when that happens.
And that is Europe's problem. The market is saying "when" not "if" any more.
To stop the spreading contagion, European leaders need to stop focusing on the sovereigns and start focusing on the banks. As we have already seen, troubled sovereign nations can be kept alive for an extended period of time, but banks can't.
But rather than growing sovereign double leverage even further -- in which a troubled nation, like Ireland, borrows from the EU to put equity capital into its banks -- if the EU is serious about stopping the growing banking contagion, it is going to have to consider its own pan-European TARP/FDIC program for Europe's largest banks.
And whether Europe has the stomach for that we'll soon find out. But until Europe divorces banking strength from sovereign strength, they will both go down together.
For whatever reason, the markets seemed to ignore this critical linkage, or at least the markets believed that individual government strength was assured by the collective strength of the various stabilization facilities put together by the EU.
For some time I have talked about Europe as a House of Mirrors where "when it works, it works well as the money flows around and around and around 'reflecting' from one country to another. But when one county breaks, the stream of light (money) stops, and given the interconnectedness created by all of the mirrors, the entire house runs the risk of going dark."
What the situation in Ireland reveals is that you can have a well-funded sovereign nation and a banking system liquidity crisis, because well-funded doesn't mean solvent. And CDS spreads make that all too obvious. When it comes to solvency, liquidity is not "confidence" as Fed Governor Warsh would suggest, but rather "anesthesia" that merely dulls the pain for some period of time until the dosage needs to be increased yet again.As Bloomberg notes this morning, the bank run has now extended from Ireland to Portugal. Yet again, credit is a coward and is fleeing uncertainty. Depositors, like bondholders, know that the intertwined European government/bank network needs less, not more debt and that someone is ultimately going to get a haircut. And with Ireland already implementing "burden sharing" and the EU suggesting that the barbershops will clearly open in 2013, there is little incentive to stick around to see when that happens.
And that is Europe's problem. The market is saying "when" not "if" any more.
To stop the spreading contagion, European leaders need to stop focusing on the sovereigns and start focusing on the banks. As we have already seen, troubled sovereign nations can be kept alive for an extended period of time, but banks can't.
But rather than growing sovereign double leverage even further -- in which a troubled nation, like Ireland, borrows from the EU to put equity capital into its banks -- if the EU is serious about stopping the growing banking contagion, it is going to have to consider its own pan-European TARP/FDIC program for Europe's largest banks.
And whether Europe has the stomach for that we'll soon find out. But until Europe divorces banking strength from sovereign strength, they will both go down together.
Position in SPY, SH, JPM.
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