Exhibit B: The Latest Bailout Failure in Europe
In a show of force designed to impress the world markets, the European Union pieced together an unprecedented loan fund worth almost âŹ1 trillion euros. The fundâs capital was made available to rescue euro zone countries in financial trouble. The European Central Bank announced it was ready to buy euro zone government and private bonds "to ensure depth and liquidity." The US Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank announced that temporary US dollar swap facilities would be opened to provide liquidity. Never have so many organizations coordinated and contributed so much to a single bailout effort!
So what was the ultimate effect of this shock and awe campaign? After enjoying a short-lived obligatory rally, the market for stocks, bonds, and the euro (in terms of USD) traded lower by the end of the week. Gold, a barometer of fear, appreciated almost 6% in euro terms over that same week.
Which brings us to the crux of the problemâŚ
Exhibit C: Over-Levered Banks
Banks are at the epicenter of this financial crisis. The reason? Leverage. We outlined our measurement of bank leverage in our article Donât bank on the Banks in November 2009. As equity investors we worry about the impact a change in assets will have on a banksâ tangible common equity. Readers will note that the German financial regulator recently banned naked credit-default swaps of euro-area government bonds and banned naked short selling in ten German banks and insurers. It shouldnât surprise you to learn that, according to their most recent filings, German banks are some of the most levered in the world. Table B shows the leverage calculation for each of the four largest banking institutions in Germany as of March 2010.
Commerzbank has the highest leverage of the German banks at 124:1. This means that if their assets drop in value by a mere 0.8%, their tangible shareholders equity is effectively wiped out. How many asset classes do you think have dropped by 0.8% since Commerzbankâs last filing in March? We would guess almost all of them have (except gold of course). Hence the recent ban on naked short selling of German bank shares. Theyâre too vulnerable to handle the marketâs wrath.
The German banks are not alone. Most large banks around the globe are operating with too much leverage. The governments can keep the "Bailout and Stimulate" game going, but it wonât amount to much in the long-term unless the leverage issue is wrung out of the banking system. Until that happens, bailing out the banks is akin to pouring money down a bottomless pit.
The key point to remember with bailouts and stimulus is that itâs ultimately your money that the government is spending â and your childrenâs money. The numbers strongly suggest that your money isnât being spent wisely. We need real jobs and real growth, not bigger, more leveraged banks. The market isnât oblivious â it can see whatâs happening. Goldâs recent strength in lieu of seemingly âdeflationaryâ economic data confirms the marketâs doubts over government intervention in the financial system.
Needless to say, we remain bearish.
1 Heflin, Jay (April 20, 2010). Government has spent $3 trillion (and counting) on financial crisis. The Hill. Retrieved on May 27, 2010 from:
http://thehill.com/blogs/on-the-money/banking-financial-institutions/93285-government-has-spent-3-trillion-and-counting-on-financial-crisis2 We used current-dollar GDP numbers provided by the BEA to determine the marginal impact of deficit spending on GDP. There is no separate data set generated by the BEA, however the number is published in their news releases. It is also worth noting the divergence between reported numbers from the BEA. While the current dollar measurement of GDP decreased by $185.1 billion or 1.3% on 2009, real GDP was widely reported as increasing by 0.1%. This divergence is due to seasonality adjustments in real GDP and the percentage change reported is a blended increase over the 4 quarters in 2009.
3 Bureau of Economic Analysis (March 26, 2010) Gross Domestic Product: Fourth Quarter 2009 (Third Estimate) and Corporate Profits, 4th quarter 2009. Retrieved on May 25, 2010 from: http://www.bea.gov/newsreleases/national/gdp/2010/gdp4q09_3rd.htm.
4 Financial Management Service, A Bureau of the United States Departement of the Treasury. Monthly Receipts, Outlays, and Deficit or Surplus, Fiscal Years 1981-2010. Retireved on May 25, 2010 from: http://www.fms.treas.gov/mts/index.html. We adjusted the cash flows to a calendar year period to match GDP reporting.
5 Executive Office of the President Council of Economic Advisers. (May 2009) Estimates of Job Creation from the American Recovery and Reinvestment Act of 2009. Council of Economic Advisers. Retrieved on May 27, 2010 from: http://www.whitehouse.gov/administration/eop/cea/estimate-of-job-creation/
6 McPheters, Lee (February 3, 2010) What Is the Cost per Stimulus Job? Knowledge @ W.P. Carey. Retrieved on May 27, 2009 from:
http://knowledge.wpcarey.asu.edu/article.cfm?articleid=1857
7 Bureau of Labor Statistics, U.S. Department of Labor. (May 7, 2010) The Employment Situation-April 2010. Retrieved on May 27, 2010 from: http://www.bls.gov/news.release/pdf/empsit.pdf
8 Reported figures for each institution as of Q1 ended March 2010
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