Socialize the Losses!
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6/15/12

The market is continuing the rally from yesterday on enthusiasm for coordinated central bank action next week.  The banksters will provide liquidity if elections in Greece create turmoil in financial markets.  What is liquidity?  Liquidity means the European Central Bank will make paper euros available if there are runs on banks from customers withdrawing funds.  They will also provide overnight loans if banks stop making loans to each other out of concern of other banks solvency.

Does liquidity make any difference to the stock market?  No.  In the 2008 banking crisis there were unconfirmed horror stories of small businesses not being able to make payroll because their normal lines of credit might not be available.  Never happened.  These falsifications were used as justification to pass the TARP bill.  TARP was originally sold to congress as a vehicle to buy Mortgage Backed Securities (MBS), we all know what happened.

TARP money never bought MBS to provide liquidity.  TARP bought equity in Chrysler, GM and AIG.  TARP was a sham to socialize the losses in the financial industry and morphed into bailing out the United Auto Workers.  The money that went to AIG ended up paying off Credit Default Swaps (CDS) owned by Goldman Sachs, J.P. Morgan, UBS, and a whole host of foreign banks.

The liquidity provided by the Federal Reserve was evidently not enough for the bankers (because it had to be paid back).  TARP was necessary because it put taxpayers on the hook for bank losses rather than the bank owners and the Federal Reserve.

The market is excited to see central banks ready to provide liquidity, but remember…liquidity is not equity.  An insolvent bank can be liquid but it is still insolvent.  Until the money flows to banks as equity, or non-recourse loans against dodgy sovereign debt, the banks that are sitting on huge losses from the Greek debt write down are still insolvent.

We saw bailout money promised to Spain last week from the EFSF or ESM (to be determined).  Spanish politicians are adamant this money is to shore up their banks.  Why are their banks teetering on insolvency?  The number one reason is real estate loans that have gone bad but also because they are chocked full of Spanish sovereign debt that is not worth face value.

Spain’s credit rating is just one notch above “junk status” at the present time.  If it drops one more notch the ECB will charge a five percent premium on any Central Bank loans collateralized by Spanish sovereign debt.

According to Reuters, Spanish banks held $185 billion dollars’ worth of Spanish bonds at the end of April.  Italian banks own $370 billion dollars in Italian government debt.  Greek banks lost 75% on the government debt they held when private bondholders were wiped out in the last bailout.

The situation becomes even more difficult for banks if they must sell sovereign bonds in the secondary market.  A Spanish 10 year bond that pays 4.0% was trading earlier this week to yield 7%.  To get to that yield could reduce the value of the bond by up to 40% depending on length of time left to maturity.

With all the excitement surrounding the Central Bank’s declaration they will provide liquidity, watch for moves by banks to socialize their losses.  This is the basis behind letting the European Stability Mechanism (ESM) rescuing banks directly rather than going through the government.  Hollande of France is the main proponent of direct bailouts for banks.

This keeps his hands clean and shifts liabilities to other eurozone countries (Germany).  This is why Angela Merkel and German voters are cautious.

Mailbag:
Loved your story about EU members paying to bail out Spain especially the part about Italy having to chip in 20%.  It made me think, do you foresee a situation in America's future where say a state like Kansas or Texas would have to pay into a fund to bail out California?---Long Term Subscriber M.T.

John’s reply: Nope.  But you can believe California wants to suck at Obama's trough.

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