It's The Economy Stupid: How big is the Euro trash can?

Okay, so once again Euro Land’s problems are casting a nasty shadow over the world’s financial markets.  If independent analysis is correct, losses on some bank’s debt pipelines dwarf their equity capital and large bank bailouts of some sort will likely occur.  So, the question is “How big is the Euro trash can?”

 

Using the simplest estimates for the European banks and applying them to current capital positions, a lot of these banks seem to be under water. They don't have enough capital to meet the expected losses from the debt of peripheral countries that they have taken on.

 

Overall, we have a classic example of a liquidity problem that has morphed into a solvency problem. But  the world is not coming to an end, it is solvable, it’s just that the solution in Europe is likely to look like the past solutions in South America.  What’s likely to happen?  Well, bond holders will likely have to take a haircut on their PIGS (Portugal, Ireland, Greece, Spain) sovereign debts.  The bond holders of the troubled European banks will also likely take a haircut on their bonds.  And unfortunately, the equity holders of the troubled European banks will likely be wiped out when takeovers occur. 

 

Why will the equity holders of the troubled European banks likely be wiped out?  Because the sovereign nations no longer have the balance sheets to bail them out, so they are going to have to close them and transfer the assets to banks with stronger balance sheets.

 

Investors should look for bank mergers, major asset sales and widespread company restructuring.  Which banks?  Well, that’s the REAL problem with the financial markets.  No one is absolutely sure which banks, no one is sure how bad the problem is, no one is sure how badly this will  affect the world’s economy.  So it casts uncertainty on the earnings estimates of the securities of the world’s financial markets.  And markets don’t like uncertainty.

 

John Broussard

Assistant State Treasurer

Chief Investment Officer

State of Louisiana

Department of the Treasury

Ph:  225-342-0013

Fx:  225-342-9721

Email:  jbroussard@treasusry.state.la.us

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Baton Rouge, LA 70802

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