Western European and US governments share something in common: the US government thought certain favored donors, er, “financial institutions,” were too big to fail. That’s nothing new. The government, or US taxpayers, have been bailing out Wall Street and the big money center banks since the turn of the century -- the 20th century, that is.
Just in the 40 years since I entered this business, US taxpayers have saved the big bank executives and, to a (far) lesser degree, their shareholders, from their own hubris and arrogance a number of times.
There was the Latin American fiasco, the one where then-Citibank, then-Chairman Walter Wriston sniffed, “Sovereign nations do not go bankrupt,” in response to the question, “Are you comfortable with 300% of your bank’s equity being tied up in those nations?” Ummm, Wally -- yes, they do. Then there was the Long Term Credit mess, to which we might add the Asian Contagion, the Mexican Mess and heaven knows how many other stupid moves made by brokerages and banks.
Back in the day when brokerages were private partnerships, the partners actually did their due diligence before extending credit to those their analysis indicated were creditworthy borrowers. Nowadays, awash with Other People’s Money, they don’t care because they know the federal government will bill taxpayers in Iowa and Oregon to bail the Wall Streeters out.
But, worse, in too many cases, Wall Street doesn’t analyze the unintended consequences of the instruments they’ve created to allegedly protect themselves. That’s not to say their risk managers don’t think these things through; but rather that the senior people listen to their risk managers, then figure how much dough they can make if they accept the risk anyway (never forgetting the most important consideration: how much higher their bonuses would be if it works out.)
They want to hang out there in Riskland; if things work out, they make the big bucks, if they don’t work out and their risk was high enough they’re dubbed “too big to fail.” (Want to really reform Wall Street? Give everyone a salary, with just one year-end bonus for all, based upon earnings minus a haircut for regulatory investigations, amount paid to their lawyers and outside law firms, suits settled “without admitting wrongdoing,” and “no contest” pleas entered. You’d clean the place up in a week.)
Western Europe has a rather different problem. The bonus structures still provide ample incentives for the Nick Leesons ($1.4 billion hit to Barings Bank,) Jerome Kerviels ($8 billion hit to Société Générale) and Kweku Adobolis ($2 billion hit to UBS) to, shall we say, “over-reach,” but the entire structure of Euro banking and brokerage makes theirs a different set of issues.
First of all, banks and brokers are usually one and the same in Europe. They do it all, with no walls between them: insurance, banking, brokerage, trust, money management, etc. These linkages have created problems for years and have resulted in far more regulatory oversight. Whether the oversight has been effective is open for question.
The other huge difference in Euroland is that the banks are owned, partly owned, or “heavily influenced” by their respective national governments. So when you hear that the banks in Europe face X dollars of risk because of their holdings of Greek, Italian, Spanish or other nations’ corporate and sovereign debt, you need to know that the governments who are their bed partners are also on the hook for these loans and will feel the pain in the event of any default. Which brings us to...Greece.
In my opinion, if Greece hasn’t defaulted on its next tranche of debt repayments by next quarter, just wait a year. I believe Greece will be going back to the drachma as they are ushered out of the Euro Currency system. They may be given some auxiliary or probationary status to calm the rest of the world’s markets, but it will be probationary in name only. I see default as virtually inevitable. I think the only reason the real leaders of the Euro community seem to be dithering over announcing their decision, is to make the default more orderly: figuring out which banks/nations have the most exposure, creating safety nets for them, being prepared to announce on the same day they announce their Greece decision that Germany has bought X percent of Bank A and The Netherlands has purchased Y percent of Bank B, and so on.
As a non-member of the Eurozone, Greece will be absolved of its EC responsibilities and could (like the U.S. government did) print new money to purchase their outstanding debt. Greece has no reasonable choice other than giving stadium naming rights to the Acropolis. (I’m kidding! Dear God, if Larry Ellison is reading this, he’s already got his secretary dialing the Greek Prime Minister, whoever that might be by tomorrow…)
Even more importantly, the Eurozone has no other choice. If Germany, France, The Netherlands, Finland and the other more fiscally responsible nations bail out Greece, what message does that send to both the responsible Italian citizens and their hopelessly irresponsible government? PM Berlusconi has already done terrible damage to bella Italia; can you imagine what he’d do to remain PM if he realized stupid actions have even less consequences than he imagined?
All the other nations in trouble would be handed a large club to beat the others with, including the, “What, Greeks are better than Spanish?” card. Europeans are terribly concerned with political correctness and not offending each other -- probably because every time they offend each other, they start catastrophic world wars.
The resulting money-printing of more than one bailout would inflate the Euro so severely that Americans could travel there at parity with the USD. That’s why I see a “haircut” for the current institutional/national, and possibly individual, holders of Greek debt and backroom deals to protect the banks. Then the current drag on the Euro is lifted and I “might” cover my EUO (short Euro) position.
In the US, Europe and the rest of the world, the “too big to fail, too big to bail” problem comes down to the incestuous relationship between banks and governments. When the US or the UK or China need to borrow money (so they can then inflate their economies and repay the principal in dollars, pounds or yuan worth far less) they have to sell their sovereign bonds someplace. Individual investors could take a certain amount. Community and regional banks, small insurance companies, and the occasional pension fund could buy more. But the real buyers are the big banks. They then push product to the biggest pension funds, mutual funds, smaller banks in their orbit, and individuals. Bonds are sold, not bought, and so the beat goes on between banks and governments. Let the banks fail and what happens to the value of those bonds?
Of course, until the EC gets its act together, Greece itself cannot move forward. Today, it must make all decisions in concert with its fellow EC members. Once it is free of all this, Greece can pay its debts while -- if they’ve learned their lesson there -- continuing austerity measures, albeit perhaps a bit less draconian, and finally get their house in order. In a world where demographics dictate increasing uses of energy, Greece’s seaborne transportation assets and harbors are still a growth industry, lest we forget. And their key geographic position gives them a unique perspective between eastern Europe, western Europe and the Mediterranean nations. And makes them an important and courted ally to nations transiting the Black Sea, the Suez Canal, the Mediterranean, and the Aegean. Wouldn’t it surprise a lot of analysts if, after all this tearing of hair and gnashing of teeth, the Greeks may do just fine.
What to do if you agree with me? Don’t buy Greek bonds! Instead, expect all markets to stop obsessing over Greece and move forward. Buy the best US and European companies on dips as the short-term news gives you the opportunity. We are buying, among others, Total (TOT), Telefonica (TEF), Celanese (CE), Corning (GLW), Encana (ECA), Natural Resource Partners (NRP), AXA (AXAHY.PK), Pepsico (PEP), Schlumberger (SLB), Statoil (STO), Weyerhaeuser (WY), ABB (ABB), Teva (TEVA) and Zurich Financial (ZFSVY.PK).
Need instant diversification? Do your own due diligence and buy on dips the equal weighted ETFs like RSP, RHS, RYE, and RYU, all of which we are also buying, or those I suggested that you research here, in my article last month subtitled “Prepare For the Next Leg Up.”
Disclosure: We, and/or those clients for whom it is appropriate, are long VWO, EFG, RSP, RWX, RHS, RYE, RYU, TOT, TEF, CE, GLW, ECA, NRP, AXAHY, PEP, STO, SLB, WY, ABB, TEVA and ZFSVY. We eat our own cooking.
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