Europe & the banks.

23rd September 2011

Ian Copelin, Investment Director, my wealth comments, “There is no doubt that much of the current uncertainty (and equity markets do not like uncertainty) is due to the policy paralysis in Europe.  The current politicking and different preferences of governments in Europe’s highly fragmented decision-making structure is causing complete gridlock and is not doing Europe (or the rest of the World) any favours.

Although I am concerned that the dithering politicians won’t act quickly enough to avoid a recession in Europe, I do strongly believe that they will stop the use of sticky-plasters and will address the deeper economic challenges as the alternative is a dissolving of the political and economic ties between member states within the eurozone which is a massive step into the unknown.

The Swiss bank, UBS, recently estimated that if Greece left the eurozone, it would cost each Greek citizen between €9,500 and €11,000 in the first year, and €3,000-€4,000 per subsequent year.  UBS also estimates that if Germany is to exit the euro, it would cost €6,000-€8,000 for every German in the first year of exit, or 20-25% of the country’s GDP.  The reintroduction of a ‘safe haven’ Deutschmark, would negatively affect trade between Germany and its core market, the eurozone.  These costs are massive and a big incentive for the politicians to stop bickering and start acting as one – the survival of the Euro is in everyone’s interest, especially Germany’s.

In comparison, the cost of bailing out Greece is tiny – UBS estimates that the cost of bailing out Greece along with Ireland and Portugal would cost just over €1,000 per person.

The banks are the most affected by this uncertainty as the size of loans and the potential scale of any write-downs and the adequacy of the capital reserves required to absorb these write downs is not known.  However, since the start of the credit crisis in 2008, banks have significantly strengthened their balance sheets through deleveraging and capital raising (a recent note from Barclays Capital estimates that banks have raised around $390bn of new capital).  In a separate Barclays Capital research note on the French Banks (believed to be the most exposed to a Greek default), it suggests that the current depressed share prices are already discounting significant amounts of further write-downs on peripheral sovereign debt holdings, which actually leave the shares valued on large discounts to the returns they forecast.”

Ian Copelin, Investment Director, my wealth also comments, “Yesterday the S&P 500 fell 3.19% and the Dow Jones 3.51%, as the market started to feel cheated that ‘Operation Twist’ involved no creation of ‘new’ money and simply aims to distort the yield curve (see the note below published yesterday). Interestingly, the Fed statement showed there were a number of dissenters – so I would suspect that if Ben Bernanke, the Federal Reserve Chairman, had a free hand he would have been adventurous/ aggressive and implemented a new programme of Quantitative Easing (QE).