European Bank Woes & the Super Committee

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

November 15, 2011

IN THIS ISSUE:

1.   Old Debts Threaten European Banks

2.   Is the Super Committee Doomed to Fail?

Introduction

We begin today with highlights from a surprising article written by David Enrich and Laura Stevens that appeared in the Wall Street Journal last week. A recent research project from Credit Suisse revealed that the largest European banks are sitting on a ton of old, pre-credit crisis assets, much more than previously believed. This is really scary stuff!

Following the article below I will discuss the latest progress, or lack thereof, made by the so-called “Super Committee” that is charged with finding at least $1.2 trillion in budget deficit reduction over the next 10 years. The Committee’s deadline is next Monday, and let’s just say the odds look grim for a successful outcome.

But first, here are the highlights from the recent Wall Street Journal article. Read it carefully:

Old Debts Threaten European Banks

QUOTE: European banks are sitting on heaps of exotic mortgage products and other risky assets that predate the financial crisis, adding to pressure on lenders that also are holding large quantities of euro-zone government debt.

Four years after instruments like “collateralized debt obligations” and “leveraged loans” became dirty words because of the massive losses they inflicted on holders, European banks still own tens of billions of euros of such assets. They also have sizable portfolios of U.S. commercial real-estate loans and subprime mortgages that could remain under pressure until the global economy recovers.

While the assets largely originated in the U.S. financial system, top American banks have moved faster than their European counterparts to rid themselves of the majority of such detritus.

Sixteen top European banks are holding a total of about €386 billion ($532 billion) of potentially suspect credit-market and real-estate assets, according to a recent report by Credit Suisse analysts. That’s more than the €339 billion of Greek, Irish, Italian, Portuguese and Spanish government debt that those same banks were holding at the end of last year, according to European “stress test” data.

Many are holding tens of billions of euros of bonds issued by financially shaky countries. They are holding hundreds of billions more in loans to customers in those same countries, which are likely to go bad at an increasing clip if Europe's economy continues to struggle. 

 Suspect Assets  

The Royal Bank of Scotland is sitting on €79.6 billion in credit-market assets dating back to the first round of the financial crisis. The situation is heightening fears that the banks lack enough capital to absorb potential losses and could require government support.

…The banks generally have been holding the assets since before the financial crisis got under way four years ago, a time when real-estate assets in general had much higher prices. Some banks haven't fully written down these loans to reflect their current market values.

European banks, on average, have roughly halved their stockpiles of the legacy assets since 2007, the Credit Suisse analysts found. Meanwhile, the top three U.S. banks—Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co.—have slashed such assets by well over 80% over a similar period.

“There’s been very much a pattern of just holding them,” said Carla Antunes-Silva, head of European banks research at Credit Suisse. “It will be another drag” on the banks’ capital and returns on equity. Bank executives in Europe play down such concerns. They say they have reduced their exposures to risky assets and have enough capital to soak up any losses. 

…The assets could lose value due to a wave of selling by the banks. Last month, regulators instructed many European lenders to come up with a total of about €106 billion in new capital by next summer. Bankers, analysts and other experts say that dumping leftover credit assets is likely to be an attractive method of finding the funds.

French banks in particular have pointed to such sales as a key part of their plan to address a cumulative €8.8 billion capital shortfall. If the banks sell the assets at a loss, it erodes their profits and can dent their capital bases.

…Banks in the U.K., France and Germany are the biggest holders of such assets, even after chipping away at their exposures. The four biggest British banks reduced their holdings by more than half since 2007, while four French banks trimmed theirs by less than 30%.

Barclays PLC, for example, is sitting on about £17.9 billion as of Sept. 30, down from £23.9 billion at the start of the year. The assets, which landed on the giant U.K. bank’s books before mid-2007, include collateralized debt obligations, composed of securities backed by assets like mortgages, commercial real-estate loans and leveraged loans that helped finance boom-era corporate buyout deals…

At roughly €28 billion, Crédit Agricole SA has the biggest portfolio of such assets among French banks, according to Credit Suisse. The bank’s June 30 financial report includes €8.6 billion of CDOs backed by U.S. residential mortgages.

Legacy assets are also haunting Deutsche Bank AG. The Frankfurt-based bank is holding €2.9 billion in U.S. residential mortgage assets, including subprime loans. It has an additional €20.2 billion tied up in commercial mortgages and whole loans. The bank says it has hedged nearly all of its residential mortgage exposure.

…Compared with European banks, U.S. lenders have moved faster to dump such assets. Citigroup, which required $45 billion of government aid in 2008, faced intense pressure from regulators to rid itself of risky assets, many linked to mortgages that got the New York bank in trouble. Its stockpile of such assets was down by 86% to $45 billion at Sept. 30.

“It’s a very cultural difference,” said Mr. Abouhossein, the J.P. Morgan analyst. “In the U.S., you take the hits, raise equity, and move on…In Europe, it’s more, ‘Let's see more normalized pricing and then let’s get rid of it.’ “ END QUOTE

"Super Committee" - Is It Doomed To Fail? Probably

During the debt ceiling crisis in August, a compromise was reached to form the so-called "Super Committee" of six Republicans and six Democrats charged with finding at least $1.2 trillion in government deficit reduction over the next 10 years. The Super Committee's hard deadline is November 23 for delivering its report. But in reality, the deadline is next Monday, November 21, so that the Congressional Budget Office has time to “score” the proposal by November 23.

Then Congress must vote on it by December 23. If the Committee doesn't produce such a proposal on time, or if the Congress doesn't pass such a plan by December 23, then automatic spending cuts of $1.2 trillion go into effect starting January 1, 2013, so we are told. More on this below.

The Super Committee has met several times since August with the usual result: no agreement. To the surprise of no one, the Democrats are pushing hard for new tax increases (now referred to as "revenue enhancers"), while the Republicans are refusing to accept any new taxes. What else is new? As a result, most political observers concluded last week that the Super Committee was doomed to failure. But not surprisingly, the Republicans blinked last week.

While the Republican compromise was not issued formally in writing, GOP spokesmen indicated that the Republican members of the Committee were willing to accept $500 billion in various tax increases – IF – the Democrats were willing to make the Bush tax cuts permanent. The Republican offer to accept $500 billion in tax increases was based on a plan to "cap" certain income tax deductions such as home mortgage interest, charitable contributions, etc. - all formerly sacred cows.

The Republicans also demanded that there would have to be some modest cuts/changes to entitlement programs including Medicare and Social Security, which a few Democrats on the Committee have also been considering. Now you might have assumed that the Democrats would have pounced on the Republicans offer to raise taxes, indirectly, by $500 billion over the next 10 years. But if you thought that, you'd be wrong! The Democrats on the Committee rejected the GOP offer and argued that the offer was too small by at least half.  

The Republicans claimed that their plan would stimulate the economy and create millions of new jobs over the next decade. On what basis, we'll probably never know. The Democrats countered that reducing some itemized deductions while extending the Bush tax cuts and cutting the top tax rate to 28% would result in decreased revenue in the long-run. As this is written, the Super Committee remains deadlocked. Again, what else is new?

While I can't guarantee that the Super Committee will fail, the odds certainly do not look good at this point. There is only a week before the November 23 deadline, and in reality, a plan must be agreed upon by next Monday, November 21, in order for the CBO to have time to “score” it by Nov. 23. As this is written, both sides are far apart on reaching a compromise.

But who knows if some last-minute compromise might be hammered out? The latest rumors are that the Super Committee might land on some kind of two-part deal that would make less than $1.2 trillion in cuts now, with the balance to be agreed upon at a later date, presumably next year. Surprise, surprise.

I hate to be so cynical, but here's my bottom line on the Super Committee. President Obama and even members of Congress knew when they agreed to the Super Committee earlier this year that the most likely outcome would be failure or some weak and powerless compromise. President Obama doesn't really want to see government spending capped or limited in any way. Ditto for the Democrats in Congress. And excuse me, my conservative readers, neither do the Republicans, if they were really honest about it.

With a few notable exceptions, everyone in Washington wants more government spending, whether they admit it or not. Think pay raises - the more the government spends, the more they can increase their salaries. Also, the more pork barrel spending they can bring back to their home districts, the more likely their re-election chances.

My view is that the Super Committee likely fails to reach a compromise and dies. And frankly, who should care, one way or the other? It was a designed-to-fail effort from the beginning. But it looked like a good effort in the media.

And one last point. If the Super Committee fails, as I think it will, the mandatory spending cuts don't kick in until January 1, 2013. That gives Congress and Obama a full year to change the mandatory spending cuts. Can anyone reading this imagine that Congress and President Obama  won't take some actions in 2012 to avert these mandatory spending cuts from going into effect before January 1, 2013? Can you say, YES?

The Super Committee was just another in a string of hoaxes on the American people over many years. Just another trick based on how stupid they think we are. Maybe we are, but I hope not.

In any event, it will be most interesting to see how the next week plays out.

Very best regards,

 

Gary D. Halbert

SPECIAL ARTICLES

Super Committee: Growing doubts about a deal
http://www.washingtonpost.com/business/economy/on-supercommittee-growing-doubts-about-reaching-a-debt-deal/2011/11/13/gIQABgG9IN_story.html?hpid=z2

Liberals Playing to Type (excellent read)
http://www.weeklystandard.com/articles/liberals-playing-type_608016.html?page=1


Read Gary’s blog and join the conversation at garydhalbert.com.


Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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