An update on our warning...
An update on our warning... Why Europe's banks are in such bad shape... Goldman's secret report...
On Friday June 17, 2011, I sent all our subscribers the following warning, via the Digest…
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We're about to see a return to crisis-like conditions in the world's credit markets. This will devastate financial stocks. It should also hit commodity prices and commodity-related stocks hard. In today's Digest, I'll show you why I believe this will happen... |
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The next stage in the ongoing global financial crisis will feature the collapse of both the Spanish and the Italian economies. This should occur within the next six months. Concurrently, I believe the "Chinese miracle" will be unmasked as mostly a fraud powered by a huge increase in bad lending from state-controlled banks. |
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Ironically, the coming wave of financial trouble will probably force people back into U.S. dollars. Gold will also do well. In the currency markets, I believe the euro will collapse in the second half of this year, as will the Australian dollar, which serves as a proxy for the Chinese economy. |
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I expect this next "down leg" in the world's markets to be more severe than the crisis of 2008, because the balance sheets of the Western democracies are now less prepared to manage the losses... |
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... We're entering another period of soaring volatility, increasing interest rate spreads, and falling stock and bond prices. How the authorities deal with these problems will set the stage for what happens next. If they try to paper over these continuing crises again – with new money-printing programs from the Federal Reserve – you can expect a massive inflation and what I call The End of America. |
In that Digest, I suggested readers avoid European banks (and specifically UniCredit). I explained how, as the Fed ended its second round of quantitative easing (QE2) from the U.S. credit market, it would cause liquidity to dry up and "make issuing debt more expensive across the credit spectrum." And I explained China's banks were likely to experience a major crisis because of rampant fraud… and I named China Life Insurance (LFC) specifically. It's been roughly 10 weeks since I issued these warnings...
In the chart below you can see the relative performance since late June in the shares of UniCredit (blue), China Life (green), Italian stocks (red), gold (GLD), and U.S. financial stocks (represented by Bank of America, in orange). The world's financial system is down roughly 30%. Gold is up 20%. That should erase any remaining doubts about whether or not the financial crisis that began in 2007 and 2008 is still with us...
The huge fall in European bank stocks during August is only a taste of what these future funding problems are going to look like. In August, Europe's banks were forced to accept losses of at least 21% on their Greek bonds, which were actually trading down about 50%. Royal Bank of Scotland's accountants decided to actually mark their bonds to the market and took a $1.2 billion loss. The stock collapsed as a result – falling like a stone from the mid-$10s to less than $8.
There are two key points to understand. First, most of Europe's banks didn't mark their Greek debt to the actual market price. They only took 21% losses. Thus, France's BNP and Belgium's Dexia "only" lost 534 million euros and 338 million euros, respectively. That's less than RBS lost, even though both BNP and Dexia own far more Greek debt.
Most of Europe's banks took this 21% accounting compromise (Societe Generale, Deutsche Bank, and UniCredit) even though Greece will likely default at some point and even though the bonds are trading for much less than the 21%-loss level implies. That means sooner or later, these banks are going to have to take additional losses on these assets, probably more than double the losses they've already taken. That alone would make some of them insolvent. Likewise, almost all of the Greek banks would be left insolvent by a 50% decline in the value of Greece's government bonds.
The second key point to understand is... a Greek default would almost surely trigger defaults in Ireland's, Portugal's, and Italy's bonds... and a downgrade of France's sovereign debt... as investors would flee these markets as sovereign borrowers attempted to prop up the banking system.
The only solution is a massive bailout of Europe's banks. According to a recent study from consulting firm McKinsey & Co., Europe's banks will require $3.5 trillion to $5 trillion in additional capital in order to meet the new Basel III global banking requirements. And that doesn't take into account the current fragility of Europe's bank financing arrangements. Roughly 50% of European bank assets are financed using funds borrowed from the U.S. money market.
The only large sovereign lender with any real credit remaining is Germany, which for political reasons may be unwilling to bail out the entire European banking sector... and even if it wanted to do so, the magnitude of the capital that's needed would push Germany's sovereign debt total to more than 200% of GDP. It is very unlikely Germany will accept this obligation under any circumstance.
So what will happen? I see two possible outcomes. First, Germany and two or three other northern European countries might decide to simply leave the euro altogether and use a reconstituted German mark as their currency. The remaining euro countries would then recapitalize their banking systems through inflation and a massive devaluation of the euro, which would no longer be a reserve currency.
The second option is more likely – the introduction of so-called "Eurobonds." These would be new obligations of the European Union. They would be offered to other central banks around the world and provide the means to recapitalize Europe's banks by a global inflation.
Whatever the outcome... I would continue to maintain the most conservative financial profile as possible. A clear resolution of these problems remains far off. And the risk of a large-scale move away from the U.S. dollar in anticipation of a European bailout has barely begun to register in the markets.
Finally... very late last night, a confidential source sent me a copy of Goldman Sachs' confidential (and very bearish) 54-page report. It details the problems in Europe's banks and the inevitable slowdown in China's infrastructure spending – the same topics I warned you about in June. Given Goldman's reputation, the whispers about this particular report and my own research on these topics, I was eager to see it. There were a few surprises...
The most striking thing to me was how the report led with this question: "Can the U.S. continue to depreciate the world's base currency?" This is the first time I've seen a major investment bank address the risks to the U.S. dollar's reserve status. These are the same concerns I raised in my End of America videos and newsletters. Unfortunately, while the report does contain several pages of charts and facts about the ongoing problems in the U.S. economy, it never touches on that central question again. Even so... that people on Wall Street are beginning to ask that critical question is interesting and shows this crisis is growing and progressing.
Goldman's report raises that critical question. But it comes about 10 weeks after the Digest I cite above. And… quite frankly... I don't think Goldman's work is half as thorough. Perhaps it's good enough for the world's biggest hedge funds... but my subscribers deserve (and get) better.
New 52-week highs (as of 9/1/11): Keyera Corp. (KEY-UN.TO) and Eldorado Gold (EGO).
In the mailbag... an astute financial pro predicts I'll win my bet against Sean Goldsmith regarding the fate of Warren Buffett's recent investment into Bank of America. Send you feedback here: feedback@stansberryresearch.com.
"If outstanding BofA contracts (otherwise known as off-balance sheet liabilities) are all settled equitably, BofA would have little or no equity left. Buffet's investment is misguided unless he has received some assurance of support. Otherwise the investment will probably make his bloodbath with Salomon Brothers look good in comparison. The only way [Sean] can win [his] bet with Porter is if the US Treasury decides to bail out BofA with terms that are unjustifiably generous to shareholders." – Paid-up subscriber Steven Koomar
Regards,
Porter Stansberry
Baltimore, Maryland
September 2, 2011