Market Talk

Remember all the rave reviews and talk about transparency during the summer when European bank stress-test results were released? As Gluskin Sheff’s David Rosenberg reminds us today, the Irish banks (yes, the ones at the center of the bailout), “passed” those tests.

The euro and US stocks enjoyed a nifty little rally back in late July, in part on hype about the stress-test “results,” even though there was wide skepticism and derision over the testing process.

At least part of that charade is over. Back in July, Dow Jones reporter Vladimir Guevarra wrote that the Bank of Ireland and Allied Irish Banks “passed a European Union-wide stress test on the strength of their balance sheets,” according to the Irish Central Bank and financial regulator. Continue reading…

So which one of you beauties will be first to "restructure"?

“As the summer draws to a close, it is becoming increasingly clear that neither the European sovereign debt crisis nor the banking sector crisis has been resolved,” Morgan Stanley economist Joachim Fels writes.

So far, it seems the euro and the single currency’s frequent escort, US stocks, haven’t received that memo yet. They show no signs of the turbulence ignited by the last flare-up in May. But that probably won’t last.

“The sovereign and banking crises continue to mutually reinforce each other because governments need to backstop banks, while banks own large amounts of peripheral government bonds,” Fels writes. “So, not much has changed since we last described (in June) this vicious circle, called for a circuit-breaker, and concluded that the obstacles to a real solution of the banking and sovereign crisis were formidable,” he says.

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Um, is anybody really surprised? Surprised that Europe’s version of the Great Recession Bank White-Wash, i.e., the “stress test,” is being exposed as the Potemkin Village we all knew it was? The Journal’s David Enrich reports today that the way the tests were conducted allowed the banks to mask a substantial portion of their sovereign-debt risk (it’s still unclear just how much.) It may be a bit surprising that the truth is coming out just now, but it’s not at all surprising that it’s coming out.

The day the results came out, we wrote:

Let’s be frank: there is no way, no way, these tests were designed to rigorously test the strength of the European banking system. Like their American counterparts, the tests were rigged exercise designed to shore up public confidence. The truth never entered into the calculations, and why should it? Everybody already knows the truth. American banks failed a very real stress test in the fall of 2008, when the government had to come in and save the entire industry. European banks similarly failed their very real stress test this past spring.

The tests were a carefully orchestrated exercise designed to shore up public confidence. To that extent, they worked. Temporarily. Because the fact of the matter is that what’s happening now, the unraveling of that carefully orchestrated exercise, has the potential to be more damaging than if they had just come clean from the start if the public perceives that a fast one was pulled. Fool me once, shame on you. Fool me twice?

From Enrich’s story:

The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe’s financial system. “That would certainly be unhelpful to people’s perceptions” of the tests’ credibility, said UBS banking analyst Alastair Ryan. Reducing banks’ reported holdings of government debt “was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there’s not a problem.”

You’re seeing already in the credit markets that debt insurance costs are rising, for both private and public debt. As Wolfgang Munchau notes in the Financial Times, which I saw via naked capitalism, spreads between German debt and debt for the “periphery” countries (as if they’re not really part of Europe) is rising at an “alarming rate,” going back to where it was before the big EU bailout fund was unveiled. This means, simply, people are worried. Again.

Bernanke launching "unconventional measures."

Sounds as if former Fed vice chairman and Princeton professor Alan Blinder has changed his tune a bit. Hat tip to Gluskin Sheff’s David Rosenberg for pointing out this Blinder quote in a NY Times story late last week:

The Fed has run out of the strong tools, and is turning to the weak ones…When you’re fighting in a foxhole and you’ve used up the machine guns and hand grenades, then you pull out the swords and start throwing rocks.

The Times went on to quote Blinder as saying the economy seemed “substantially worse” than it did three months ago.

Interesting, Alan. Three months ago, eh? That’s around the time the good professor penned an op-ed for the WSJ (so rich we had to clip it out and save it in the bottom file drawer), titled “Government to the Economic Rescue.”

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How many of your problems have you kicked down the road that have eventually gotten better?

Hedge-fund manager Kyle Bass’ testimony before the Financial Crisis Inquiry Commission back in January was a hit with us. He’s another gent who we’d be proud to initiate into the Committee for the Continuation of Keeping It Real. Kudos to CNBC for giving him the floor this afternoon. 

He’s looking a lot more tanned and trim than in January, when he resembled more of small Gandolfini. Good stuff follows: 

Part II

- Gold dropped to a three-month low yesterday. “For gold, the battle now is between short-term traders, who see the metal’s rally as played out for the moment, and the true believers, who see gold as the only refuge from the risk of further government-engineered debasement of paper currencies,” Tom Petruno says.

- Harvard economics professor Martin Feldstein describes how difficult it truly is to forecast economic growth. “While it would be rash to forecast a double dip as the most likely outcome for the economy during the rest of this year, many of us are raising the odds that we attribute to such a downturn.”

- Nonfinancial companies in S&P 500 have a record $837B in cash, according to S&P, which is 26% higher than year-earlier figures. “The odd thing about this gigantic cash pile is that these companies are barely being paid any interest by keeping this money in cash,” Eddy Elfenbein writes at Crossing Wall Street. “It shows you just how scared they are.”

- Princeton economist and NY Times columnist Paul Krugman is baffled at the Obama administration’s waffling on whether to appoint Elizabeth Warren to head the new Consumer Financial Protection Bureau.

- Unemployment remains stubbornly high and GDP growth is slowing, but that doesn’t necessarily mean investors should avoid stocks. Peridot Capital’s Chad Brand compiles S&P 500 returns from 1958 through 2009 and concludes: “Investors choosing to own stocks only in years with negative GDP growth would have earned nearly four times as much than investors choosing to invest only when GDP was growing at 5% or better.”

- “If BP emerges from this debacle fatter and happier than anyone imagined a few months ago, whatever happened to the idea of corporate accountability?” former labor secretary Robert Reich ponders. “Does this mean any giant corporation can wreak havoc and then get back to business as usual?”

- Selling Phibro may be one of Citigroup’s best moves. “It isn’t often these days that Citigroup comes out ahead of the Wall Street pack,” WSJ’s Deal Journal says. “But at least for now, the Phibro deal is proving to be a plum.”

- “The administration would have been in a much better position today had it made a concerted effort months and months ago, even an unsuccessful one, to give the economy the help it clearly needed,” Mark Thoma writes.

- Durable goods orders slid for a second straight month, which comes as no surprise to Michael Shedlock, an investment advisor for Sitka Pacific Capital. “I cannot help but laugh at economists who refuse to see the economy is slowing dramatically, and somehow think manufacturing is going to lead the way to recovery,” he says. “That was an across the board stunningly bad report.”

- A new paper from two economists says without the Wall Street bailout, bank stress tests, emergency lending and asset purchases by the Fed and Obama’s fiscal stimulus program, GDP would be about 6.5% lower this year.

No cheating, children.

With the euro banging around $1.30, it would appear, for the moment certainly, that the broad market has decided to put the stress tests of European banks behind it. Look, stocks got the answer they wanted: 91 banks tested, 84 found not wanting. Those are numbers only a risk trader could love. All those questions about veracity and credibility, well, leave them to somebody else.

The tests were widely panned, but they did provide one valuable asset: data. The tests amounted to a giant data dump, in that banks’ asset sheets were published (more or less, some more, some less)  for all to see. What’s valuable about that is it lets anybody who wants to, conduct their own stress test.

“The market is doing its own stress test calculations and coming up with radically different answers,” Richard Smith writes at naked capitalism. JP Morgan’s Pavan Wadhwa, for one thing, estimates 54 of the banks would’ve failed had the tests been more stringent (I don’t have the original report myself, but I’m working on getting a copy) with a capital shortfall of about 60-75 billion euros, far higher than the 3.5 billion shortfall as calculated by the official tests.

Separately, Citigroup said 24 banks would’ve failed if the tests had included assets the banks were holding to maturity, Bloomberg reported. That was one of the biggest complaints, that the tests included only trading assets, which comprise a far smaller percentage of total assets.

Then there’s Nouriel Roubini, who just flatly said the tests weren’t realistic.

There will likely be more of this in the days, weeks and even months ahead. I’ll be interested to see if Chris Whalen and the crew at Institutional Risk Analyst digs in there. I know he said they don’t matter, but somehow I think a data hound like Whalen won’t be able to resist.

Listen, just keep this in mind: all these stress tests, on both sides of the pond, are for show purposes only. As per Ambrose-Evans Pritchard over at the Telegraph, they were an “operation to calm the markets,” in the words of one German regulator.

All the banks, and all the sovereigns, are constantly being tested by the only criteria that matters, reality. U.S. banks failed that test miserably in 2008. It remains to be seen how European banks will fare, as their test is ongoing, but the fact that the Europens had to cobble together a 1 trillion euro bailout plan for the entire Continent is not a good sign.

- Nokia’s (NOK) adding its own twist to the Apple/Gizmodo iPhone 4 controversy earlier this year. Nokia’s getting Russian police involved in asking Eldar Murtazin, editor-in-chief of Moscow-based mobile-review.com, to return the prototype N8, a device he gave an unfavorable review earlier this year.

- “Investors have this week been buying up names that have been hit the hardest in recent months, which is usually the case when we see bounces like this,” Bespoke says.

- Banks and regulators must take “appropriate action” to strengthen banks’ resilience to shocks and safeguard the health of Europe’s financial system, ECB President Jean-Claude Trichet says.

- Whatever happened to all those toxic assets on banks’ balance sheets that garnered so much attention a while back?

- Jobless claims dropping 21,000 to 454,000 represents a “tactical victory for the bulls,” James Picerno writes at The Capital Spectator. “But until and if the trend rolls on it’s only marginally encouraging. The strategic outlook, in other words, is still up for grabs.”

- Silicon Alley Insider says the real reason Google (GOOG) is worried about Facebook is that people buying things are more inclined to trust their friends than strangers or search ads. SAI says that’s the key message in a presentation prepared by Google researcher Paul Adams for company execs who are plotting the company’s next social network initiative, rumored to be called “Google Me.”

- Individual investors are turning more bearish, which contrarians could actually view as a bullish indicator. Only 25% of AAII’s respondents are bullish on stocks, compared to 42% who say they are bears. “I always prefer actual buy and sell driven data — prices, volume, asset allocation, etc. — versus mere surveys,” Big Picture blogger Barry Ritholtz says. “They can be useful, but have huge limitations. Us humans are notorious for saying what we hope, rather than what actually is.”

- Double-dip has dominated the market chatter in recent days. While pundits keep saying the economy won’t fall back into a recession, Reuters’ David Gaffen isn’t so sure. “It may not happen — but when a lot of people are trying to convince you that something’s not going to happen, it can make you believe that it’s more likely than not.”

- The commercial real estate market hasn’t collapsed because of a strategy known as “extend and pretend,” essentially banks giving troubled borrowers time to make good on their bets until the economy recovers. “Sometimes, it actually works. But, usually it doesn’t — especially when practiced on an industry-wide scale,” Henry Blodget writes at Business Insider.

- The LeBron James surreality show is about to begin. He’s “leaning” toward Miami, but we still have faith he’s coming to the Big Apple. Let the “LeBronference” begin.

All right, places people, we got to make this good.

The funniest thing you’ll hear today is this bit about the U.S. pushing Europe to publicize the results of its “stress tests.” I mean, isn’t that hi-larious? The U.S. government’s 2009 stress tests were a carefully orchestrated stage show intended to restore confidence in the banking system, not to necessarily uncover any meaningful information.

Now, at a G20 meeting of finance ministers, the U.S. is pushing Europe to stage their own show. From the Journal:

Worries about Greece’s ability to repay its debt, and concerns about the stability of Spain and Portugal, provide a sobering backdrop at the gathering this week in Busan, South Korea, of finance ministers and central bankers from the Group of 20 industrial and developing nations. U.S. officials said they are convinced that by publicly demonstrating the strength of its banks and promising to solidify those that prove weak, Europe might help stem the crisis of confidence.

“This crisis is multifaceted, but I believe bank stress tests can be helpful as a critical component of any comprehensive plan to restore confidence in the European financial system,” said Lee Sachs, who was, until a month ago, a top adviser to Treasury Secretary Timothy Geithner.

Listen, on the one hand, you have the stress tests. On the other, you have the Fed cutting interest rates to zero, the federal government pushing the $700 billion TARP program at the banks, the Fed buying a trillion and a half worth of bonds from the banks (and other institutional-type holders) and Congress pressuring FASB to drop mark-to-market accounting. Which do you think had the greater effect?

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I'll say, we all look smart! Why would the Fed limit our pay?

The Fed’s hoping its latest plan to expand its role in the compensation structures for large banks will reduce risk-taking in the financial sector. The Journal has the details:

The Fed’s plan would, for the first time, inject government regulators deep into compensation decisions traditionally reserved for the banks’ corporate boards and executives.

Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees – from chief executives, to traders, to loan officers – to take too much risk. Bureaucrats wouldn’t set the pay of individuals, but would review and, if necessary, amend each bank’s salary and bonus policies to make sure they don’t create harmful incentives.

Sounds good on paper, but remember, the plan isn’t a done deal yet, Yves Smith points out at naked capitalism.

“Expect gnashing of teeth and tons of pushback from industry lobbyists,” she says, similar to the stress tests earlier this year “where the big banks managed to beat back the regulators on many key issues.”

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