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"Spain's acquiescence to a bailout of as much as EUR100billion for its banks is a preludeto a much bigger question: Will Spain need a bailout for itself?" - Front Page, Wall Street Journal, June 11, 2012
On May 5 of this year, thousands of Berskhire Hathaway shareholders came together for a weekend in Omaha, for what is known as the Woodstock of Capitalism, the Berkshire Hathaway Annual Meeting. For 6 hours, questions that were submitted in advance were posed to Warren and Charlie. Question 6 and the answer that followed is pertinent to this discussion. The question: What is your view on US banks and European banks?
Warren's reply:
" We have a decidedly different view of American banks. US banks are in a far better position than they were a few years ago. They've taken many of the abnormal losses, and buttressed capital in a big way. They have liquidity coming out of their ears. The American banking system is in fine shape. The EU on the other hand is gasping for air. Mr. Draghi opened his wallet and came up with EUR 1 trillion or 1/6th of all bank deposits in the US. It was a huge act by the ECB, designed to replace funding that was running off.More wholesale funding in Europe versus more natural funding in the US. Wholesale money can leave more quickly.... It is night and day. When Paulson and Bernanke said we'll do whatever it takes, we knew that they had the power to do so. Its not the same with 17 countries. If I want to call Europe what number do I dial? Kissinger? If I had 17 state governors and all agree on a course of action when there is panic in the markets, we would have a different outcome".
The EU is in dire straits. A couple of years ago it was said that the US' TARP and QE2 was the Fed's way of 'kicking the can down the road'. If that is the case, the EU has only recently decided to admit a can is on the road, and has begun the kicking in the last couple of months. The challenges are immense, and include 17 nations with markedly different values and work ethic,s social security and taxation systems, productivity output and economic and budget management. The probability that the 17 will collectively agree on a uniform resolution, and who will bear the consequent burden, is small. At the end of the day, European leaders can agree all they want, but then they must turn inwards and face their own domestic constituents, who are unwilling to think collectively.
This weekend, the EU rushed to the rescue of Spanish banks, with its decision to lend up to EUR100 billion. Why? A couple of reasons:
(1) In 6 days [June 17], Greece will hold elections. If Greece's Coalition of the Radical Left - the SYRIZA party wins, they have declared that they will renege on the terms of the Greek bailout agreement, and demanda renegotiation. This will result in the EU & IMF to suspend their aid payments, leading to a Greek default in September. It is likely that this will result in Greece leaving the EU, and will have a 'contagion effect' on Spain and Italy.
(2) Spain needs to borrow EUR86 billion to cover deficits and repay maturing debts. It is estimated that EUR50 billion has been raised so far, with another EUR36 billion to go. The Spanish banks have experienced difficulties in accessing bond markets. This rescue has only made access worse. This is confirmed with historic highs of capital flight from Spanish banks, which reached EUR 66 billion in March.
(3) Prolonged stress in the Spanish economy will have an immediate impact on Italy, France and Germany.
The macroeconomic situation in Spain is not pretty.
Spanish National Debt is 68.5% of GDP.With this rescue, it will increase to approximately 79%.
Unemployment is closing on 25%,and while the numbers of the annual budget deficit had been heading in the right direction, the EUR 100 billion rescue will reverse that.
The graphic below speaks for itself. Take a look at Italy. Will it be the next in line to need rescuing?
There is little doubt that 2012 is going to be a memorable year for the EU.
Greetings valued readers - and readers of value!
I'm back. And it's not without good intent. I have a strong feeling that Value Investing 'hunting season' will soon be declared, and I hopefully there will be some wonderful opportunities to bag some elephants.
I bade you farewell in January of 2008 as I left the world of money management to take up a senior executive position with Israel's largest and oldest bank. I am still with the company. My timing - though unintentional - was impeccable. Global markets in the past four years witnessed levels of uncertainty and volatility that had never been experienced before. When I first began 'this game', a 1-2% market correction in one day would make headlines. Not today, with such corrections happening with greater frequency.
For value investors, the challenge is far greater - investors go defensive and flock to quality. The obvious blue chip high moat' plays have little margin of safety. One needs to dig deeper, seek new markets, and be creative. Which is why I have returned. I very much miss the intellectual challenge in unearthing value opportunities, and I am beginning to recognize storm clouds amassing on the horizon. It might just be the Perfect Storm.
Let's quickly recap some of the major events that have rocked global markets in the past 50 months.
2007 was the opening shot, when we quickly came to grip with those 3-lettered monsters- CDO's and MBS's, and the infamous Sub-Prime Crisis.
2008's first victim was Societe Generale, with the EUR5 billion 'unauthorized trading loss' at the hands of trader Jerome Kerviel. We saw the UK's bank run of Northern Rock, soon followed by the collapse of Bear Stearns. Other institutional bailouts or busts included: Countrywide Financial, Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Citigroup and AIG. Incrediby, Citigroup's market value went from USD$244bn in 2006 to $20.5bn. 2008 also saw the UK treasury bailout Lloyds and RBS with a $64 billion injection. The end of the year saw the first sovereign bankruptcy - Iceland, which was the first country that I visited in my new role. It would not be the last.
2009 saw the bailout of the major Irish banks, and we learned of the infamous Bernie Madoff, and his $65 billion ponzi scheme.
2010 was characterized by QE2 - the Fed's attempt to jumpstart the US economy. It was also the first time that we heard the acronym PIGS - to denote those countries that are most likely to face a sovereign debt crisis.
2011 saw UBS trader Kweku Adoboli lose USD2 billion in 'unauthorized trades'. The high debt, no growth economies of Greece, Portugal, Spain and Italy were a major focus, and we all quickly understood the meaning of 'contagion'. By the end of the year, Greece was undoubtedly the economic pariah of the EU.
And now here we are.... 2012. 6 months ago anyone speaking about Greece leaving the EU was considered mad. Now it's a veritable possibility. Last night Fitch announced a downgrade of Spain by 3 notches to BBB.
With all this market turmoil, and talk of an EU-break-up, I'm expecting further weakness in the markets. The prospect of regional conflict between Israel and Iran will also add to market weakness - and some interesting buying opportunities.
Great to be back - wishing you all a great weekend.
Avi
