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ECB Will Let Stock Markets Crash In 2014

I read in this morning's FT, that banking regulators in Europe are essentially saying "The banking system will be solvent very soon. We mean it this time.". Granted, we heard the European banking system was fine shortly before some epic bank implosions and after bogus bank stress tests over the past few years. Could it be this time is different? (link to the FT article here)

According to the European Banking Authority (EBA) the largest 42 banks in Europe (the systemically important ones) will be able to meet Basel III capital rules by February 2014. That's 5 years ahead of schedule. Nice. The EBA is trying to get this information out in front of the European Central Bank's (ECB) review of bank assets. In its first job as uber-banking-system supervisor in Europe, the ECB is going to see how healthy banks are. The ECB's banking system review will be followed by another round of bank stress tests by the EBA next spring. The objective -as was the case with previous bank stress tests- is to convince the public their financial system is sound.

And what of our (U.S.) banking system? Dr. Bernanke said the U.S. financial system was insolvent in late 2008. (Mind you he didn't say it until years later. Wouldn't want to spook anyone with reality.) The Fed's actions in 2008, 2009, 2010, 2011, 2012, and 2013 have created an environment -steep yield curve- wherein banks could generate profits at a rapid pace. It also caused banks to build mountains of reserves, ostensibly so they'd be able to withstand a banking system shock without having to be bailed-out by the public purse again. So we're good to go.

Let's review the forces that have stopped stock market crashes over the past 14 years (No, stock market crashes were not stopped by market forces. They were all stopped by fiscal and/or monetary policy actions. So if you're still long stocks, REITS, junk bonds, and commodities, you better be counting on these still working in 2014.) Will these continue through 2014?

  • Myopic, budget-blowing fiscal policies from the U.S. Congress. (No)
  • The Fed doing increasingly desperate monetary policy tricks. (No. QE is going to begin being ramped down next year since it no longer is seen to be doing anything other than inflating stock market bubbles.)
  • Governments in Europe allowing budget deficits via overspending sprees. (Nein)
  • The ECB doing desperate things -and threatening to "do whatever it takes". In so doing, infecting its own balance sheet. (As soon as the ECB thinking the banking system can take the hit that reality will exact, it will allow it. The ECB doubtless sees the erosion of its own credibility going the same way as the Fed.)
  • Bank of Japan printing / continue printing like never before. (Yes. They've got no choice. As soon as they back off, deflation will return, and the stock market and economy will plummet.)
  • Peoples Bank of China flooding its banking system with liquidity. (Partial yes. The PBoC probably wants the next crash to crush the shadow banking system since they don't control it. But it does not want to print so much that it causes food and fuel inflation to incite several hundred million rural poor to revolt. It also does not want to create another bubble supported by bad debt like it did when it opened the flood gates in 2008-2009. Those chickens are now coming home to roost.)
  • The central banks of Australia, Brazil, Canada, England, India, Russia, Singapore, South Korea, and Switzerland flooding their banking systems with money too. (Yes. But it won't be enough.)

Apparently Europe's financial system will be solvent enough next spring to withstand another financial system crisis. Be careful what you wish for.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.