Sunday, July 25, 2010

Banks: Europe not too stressed, seventh in heaven in one day in US

Euro Falls as Stress Test Results Fail to Alleviate Banking Risk Concern
stress tests of European Union banks failed to identify sources of weakness that would aggravate the region’s debt crisis. Tests show that only seven banks flunked the EU’s crisis scenario.

EU regulators scrutinized 91 of the bloc’s banks to assess whether they have enough capital to withstand a recession and sovereign-debt crisis, with a Tier 1 capital ratio of 6 percent as a floor. Governments are seeking to reassure investors about the health of financial institutions after the debt crisis pummeled the bonds of Greece, Spain and Portugal.

The evaluations took into account potential losses only on government bonds the banks trade, rather than those they are holding to maturity, according to CEBS. That means the tests are set to ignore the majority of banks’ holdings of sovereign debt, investors said.

“There’s a lack of credibility,” said Brian Dolan, chief strategist at, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey. “They don’t think the scenarios were stressful enough.”
Europe's sovereign-debt crisis, April 29, 2010
Greece sounds three warnings that reach far beyond its borders.

The first is economic. Greece has become a symbol of government indebtedness. This crisis began last October when its new government admitted that its predecessor had falsified the national accounts.

[Guambat has just started reading the Reinhart & Rogoff treatis, This Time is Different, wherein they observe "we view the difficulties one experiences in finding data on government debt as just one facet of the general low level of transparency with which most governments maintain their books. ... Lack of transparency is endemic in government debt, but the difficulty of finding basic historical data on central government debt is almost comical."]
The second lesson is political. Playing for time has backfired. Now the mooted rescue plan has climbed above €100 billion because no private money is available. The longer euro-zone governments dither, the more lenders doubt whether their promises to save Greece are worth anything. Each time politicians blame “speculators” (see article), investors wonder if they understand how bad things are (or indeed that investors have a choice). Euro-zone leaders initially refused to seek IMF help because it would be humiliating. Their ineptitude has done far more than their eventual decision to call in the IMF to damage the euro.

This political and economic failure leads to the third Greek warning: that contagion can spread through a large number of routes.
Is a Sovereign Debt Crisis Looming?
February 2010 As the dust settles from the great financial crisis, skyrocketing government debt in advanced countries presents a new risk and is prompting calls for stimulus withdrawal. However, falling output, not stimulus spending, is by far the main cause of wider fiscal deficits. Accordingly, sustaining growth—not withdrawing stimulus—should remain most countries’ top priority if they are to break the debt spiral. Crucially, markets must remain confident in the major economies’ capacity to handle their fiscal affairs, hence the need for persuasive long-term fiscal consolidation plans.

Though markets are nervous about holding the sovereign debt of the smaller Euro area members, these countries’ problems should prove manageable—assuming the European economy continues to recover and neighbors help. Among the major economies, Japan offers the greatest source for worry in the medium term.

Since 2007, debt in seven out of the nine advanced G20 countries increased by more than 10 percent of GDP. By contrast, debt-to-GDP ratios declined or are little changed in eight of the ten emerging economies in the G20.

The bigger story is the effect of the recession on tax receipts and the automatic increase of spending on unemployment and other safety nets. Total expenditures in the United States grew from a historical average of 20.7 percent of GDP to 24.7 percent in 2009, while tax receipts are expected to fall to 14.8 percent of GDP in 2009 from an average of 18.1 percent. EU tax revenue is predicted to decline to 29.2 percent of GDP, down from 30.9 percent in 2008. Reflecting GDP decline, U.S. tax revenues fell by a remarkable 17 percent over the last year, while EU revenue likely declined by 8 percent.

With only a modest economic recovery predicted in advanced countries in 2010, government debt will continue to rise as a share of GDP.

If You Think Sovereign Debt Is Just A Greek Problem, Get Ready For It To Hit Home Soon May 7, 2010
Though the U.S. is considered to be the highest order of "prime" borrower, based on historic precedent, our debt to GDP levels are at crisis levels, and are not that much lower than Portugal or Spain. When off-budget and contingency liabilities are properly accounted for, one could argue that we are already in worse financial shape than Greece.

As Americans observe the chaos in Greece, most assume that the strength of our currency, the credit worthiness of our government, and the vast expanse of two oceans, will prevent a similar scene from playing out in our streets. I believe these protections to be illusory.

Once again the vast majority fails to see a crisis in the making, even as it stares at them from close range.

Read more:

Reinhart and Rogoff also make the point,
"Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crisis is that when an accident is waiting to happen, it eventually does."
And Guambat is only up to page 11.

Meanwhile, in the real world of stress testing,

Seven more US banks collapse on day of Europe's stress tests
More than 100 banks in the US have now collapsed so far this year after another seven were taken over by regulators late on Friday – the same day that seven European banks failed a financial health check.

With rising bad debts tied to commercial and residential mortgages, the number of US bank failures this year is expected to exceed last year's figure of 140. In all, the seven failed banks had total assets of $2bn.

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