Tuesday, 6 September 2011

Black September?


Forecasts made in a number of posts on this blog are regrettably taking shape. Today’s (Monday’s) sell-off of banking stocks over fears of exposure to an Italian debt downgrade resulted in Royal Bank of Scotland, Societe General and Credit Suisse lost over 8% in a single day. When a single rating agency, S&P, downgraded the United States from AAA to AA in August, the sell-off resulted in a similar magnitude drop, with an equally quick recovery.

Italy’s problems are far worse than the United States’.  All three rating agencies have Italy on review and will be announcing results in mid- to late September or early October. The recent flip-flop in the Berlusconi government’s austerity plan has not helped matters, and is the proximate cause of todays’ volatility.

It is impossible to tell where the “Lehman moment” will occur. This may be a mix of bank failure, as sovereign bonds are “marked to market” (few banks are willing to do this; most are “marking to model”). This may also be a sovereign debt crisis similar to that which pushed up Greek, Irish and Portuguese rates, but for a commensurately larger economy such as Belgium or Italy. It looks like Italy is next in line. Spain remains quiet, but the crisis is far from over in that country.

As stated repeatedly here: European policy-makers are trying to treat symptoms, not root causes. They are doing so in an infuriatingly slow manner, challenged (rightfully) by their voters and (less rightly) by ancillary political and commercial interests at every turn.

Efforts by observers such as Christine Lagarde, IMF managing director, to suggest recapitalisation of European banks, have been rebuffed by a number of policy-makers. Yet a banking crisis is a real consequence of a sovereign debt crisis, as we saw in today’s sell-off. And if the banking system fails, then any economic recovery will take that much longer to implement, if it can be implemented at all. Recapitalisation is the natural response to a market valuation of sovereign bonds held by banks. It is understandably difficult in the current climate.

There are also real dangers for Greece. Although many Greek commentators have been smugly commenting that Greece was in the vanguard and no longer the only “target of speculators”, this viewpoint ignores the fact that the second bail-out hasn’t been approved, and depends extensively on privatisation receipts and private sector participation. Neither the second bail-out, nor the privatisation targets will be possible to deliver if a financial firestorm hits Europe this month.

As I have stated repeatedly in this blog, as well as on my corporate pages: prepare for the worse. We are entering a period of extreme volatility, partly due to technical issues (computer trading models, shorting, rating release schedules) but also partly due to fundamentals. We have not yet touched bottom with any degree of confidence. There are excellent momentum-trading opportunities right now, but for the average citizen, there is only fear, confusion, anger and disbelief as the full extent of the failure of politics is exposed.


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