Wednesday, April 11, 2012

FW: Shhh!!! Don't tell anyone, Spanish banks have problems

This is a GREAT piece on Spanish banks by David Zervos of Jefferies &Co.

Just in case you thought it was safe to go back into the tapas.

John Broussard
Assistant State Treasurer
Chief Investment Officer
State of Louisiana
Department of the Treasury
Ph: 225-342-0013

-----Original Message-----
Sent: Wednesday, April 11, 2012 8:09 AM
To: John Broussard
Subject: Shhh!!! Don't tell anyone, Spanish banks have problems

Any investment professional who does not know that Spanish banks are having a lot of trouble should be fired immediately. This is NOT news - everyone worth their salt is painfully aware that the entire peripheral European banking system is technically insolvent. Without the life support of the LTRO and SMP, most of southern Europe would have defaulted on both its bank and sovereign debt by now - or they would converted these debts back to their pre-EMU currencies.

There is no chance that taxpayers in any peripheral country will vote to cough up the wealth or future income commitments necessary to pay these existing debts in "current" euros. Who would vote for a candidate that proposed such a preposterous solution?

It is of course the creditors of northern Europe that will ultimately lose here, as we have pointed out hundreds of times in our commentaries over the past couple years. But the northern European politicians keep postponing the inevitable by setting up ECB or fiscal bailout structures. They do not want to expose the ugly truth of wealth destruction to their voters - that is political suicide.

That said, one day, the truth will be revealed and there will be some very unhappy pensioners in Rotterdam, Vienna and Dusseldorf. Sadly, after all their hard work, these folks still won't be able to afford that beautiful Tuscan villa! And of course, living in that villa will be a happy Italian couple who could turn it into a well priced B&B once the Lira is reintroduced or once Mario turns the Euro into a Lira! Either way it works just fine for the happy Italians and the rest of the south!

Besides some disheartened hard working northern pensioners, there is really not much to concern ourselves with in Europe. The thrifty savers of the north will be slighted, and the mischievous southerners will default, redenominate or print. And after some healthy competitive devaluation exercises, all will be equilibrated in Europe. Happy days!!

Could it be a bumpy road? Sure. Could investors freak out and occasionally sell a few risk assets? Sure. But the problem is fully transparent. Will anyone be shocked if there is a portuguese PSI, a Greek EMU withdrawl or a Spanish bank default. Nope. Will anyone be surprised if an Italian leader of the ECB pursues a 7 percent inflation target in Germany while Italian inflation is running at 1-2 percent. Nope.

The ECB now has the tools and the leadership to reflate/monetize. The ECB is basically a Bernanke Fed. The Buba can choose not accept peripheral collateral and jump up and down and complain every other Thursday in Frankfurt, but it doesn't matter. The losses will be realized/monetized and the north will take a wealth hit. But of course we will have some political gamesmanship to try to obfuscate these losses.

In order to detract from the ECB monetization and competitive devaluation strategy, Mario can talk tough and comfort his German colleagues. In fact, Mario might even be happy to see some Spanish dislocations (is there an Italian word for schadenfreude). The north will always need the ability to point a finger at the "bad guys", and show that high borrowing costs arise from profligate spending. But all of that is posturing. The reality is that the ECB will only let it go so far before action ensues. With Mario in charge the barometer for policy change is probably 2yr BTP yields. If they rise up north of 4-5 percent again then we will see aggressive accommodative policy moves. The stress stops with Italy!

The idea that Spain is some "new" problem that requires a swift drop of 4 percent in spoos in the past few days is preposterous. Markets are flightly as always and European jitters seems to always send a wedge of babbling black swans flying overhead. That's just fine though - we have Bernanke bazookas fully loaded and ready to fire, and we have an MIT educated Italian at the helm ECB with bazookas of his own. We will very shortly be yelling "black swan down" and counting our winnings from standard dip buying activity.

At the end of the day we are still up over 8 percent for the year in spoos, and anyone that correctly hedged their risk assets with blues to start the year has solid double digits returns. It is still very much a spoos + blues world as we have suggested for a long while now! There is no glory, or restful nights, in owning risk assets outright. You have to have a positive carry hedge that takes advantage of the FACT that the Fed will keep short rates too low for too long and drive risk assets to bubble levels. Its also a good bet the Mario will do the same. The European version of the spoos + blues trade is probably best represented as dax + bobls (I need to find a rhyming version of this). The weighting is the same as ever 100m in risk asset, hedged with 100k/01 in the rate hedge. Good luck trading.


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