ISRAEL VALUE INVESTING: Europe - The Writing's on the Wall

"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.