Trading A Belgian Bank Bailout

Includes: DB, SAN
by: Michael Shulman

Did you say Belgium?

Yes, that feisty little country of eleven million. Even Caesar had big problems with the Belgae. “Wary of the numbers and bravery of the Belgae, he initially avoided a pitched battle.” (Wikipedia)

The same can be said for European bank regulators but they gave in to the inevitable and conquered the Belgians yesterday – regulators from France and Belgium decided to bail out and bust up a totally wayward Belgian bank laid low by the Greek and related debt crises in Europe. It’s official – we have now exported the ultimate export, “too big to fail.” Europe, welcome to The New Normal.

This bailout – and it is the first bank bailout in Europe, at least one that is actually being called that – prompted finance ministers from the entire eurozone to say we may need to do the same for the entire European system and that in turn convinced traders that even terribly run outfits like Dexia of Belgium is too big to fail. No details, no promises, no names. No matter. The announcement hit the wires around at 3:15 on October 4 and the S&P went up 4% in 45 minutes after that vague statement. Ah, the New Normal. No, let’s call it New NOT Normal.

To keep it brief, the Europeans have been willing to bail out Greece, even those paragons of fiscal virtue, the Germans - more on that in another column, in realty the Germans are about as fiscally prudent as Kim Kardashian when meeting with a wedding planner, but unlike Ms. Kardashian, they shun headlines. Why? In order to avoid their own banks from melting down and requiring a bailout, bankers are disliked even more by voters than Greeks retiring at public expense at the age of fifty. If Greece defaults – they will, next year – most European banks, including the Germans, will take a huge hit on their balance sheets and will need to raise capital, which will not be available from private investors so they will need to be bailed out. This will anger taxpayers more than bailing out those wayward Greeks. So, to date, the politicians have put off the inevitable, more money for the banks.

The inevitable hit yesterday in Belgium. For those of you not into waffles or the middle pages of the Financial Times of London, Dexia is the bank in question, they have been unable to get short term funding for their operations due to their exposure to all sorts of sovereign and other debts. Moodys warned they would be soon downgrading the bank – sort of like putting the strawberries on the plate after you have eaten the waffle – the stock took a hit and regulators and politicians stepped in and announced they would structure a bailout.

And like Caesar conquering the Belgae – this set the man up to do the same in Britain, giving him accolades and large silver mines – the regulators and governments in questions got accolades from markets but instead of getting silver, they need to spend a great deal of silver.

Bottom line from this Belgian bailout – the waffle (I could not resist, sorry) over re-capitalizing the banks in Europe is beginning to end. It will take months, maybe years, there will be lots of headlines and teeth gnashing but it will happen. Right now, the talk is about “guarantees” of debts, and these legacy debts total roughly $17.50 billion dollars. These guarantees are going to end up being cash injections into the bank. And once a structure and some numbers are in place, European leaders will move on and let Greece default.

The longer the delay the higher the cost. Did I mention the Belgian government guaranteed and otherwise supported Dexia assets to the tune of $121 billion in 2008?

And did I mention that Dexia passed the European bank stress tests this past summer – everyone though these tests were a joke, this is proof – and this problem underscores there is no logical reason investors should believe anything about the safety or health of European banks.

What does this mean? First, more headlines for traders as speculation increases on “whose next?” to be bailed out. Second, investors now know regulators have no serious understanding of how to properly evaluate the banks or if they do are not sharing with the public. They will stay away as they anticipate more problems and future needs for capital that will dilute existing shareholders. Three, there will be continent wide bank re-capitalizations – forget guarantees, this really means more capital over time for the banks from the public treasury – first on a name by name basis then individual countries will emulate what we did in the US three years ago and re-cap all banks in their country as needed. This will result in tax payer money going into the banks – and not being put into social welfare and other government programs. This, in turn, means more austerity and a deeper recession there – and here.

But you can start your trading in Europe. The obvious plays are shorting the European banks long term to get past the headlines, the big dog is Deutschebank (NYSE:DB), followed by Bank Santander (STD), you can short them here. You cannot short any bank, right now, over there. That regulatory strategy worked well for Lehman and Bear, didn’t it.