No Stress Eurodudes

who's stressing now?

Everything’s hunky-dory in Euroland these days.  Hey why not, after all last week its supposedly beleaguered banks passed the much-vaunted stress tests with flying colours right?

Well kinda.  It would seem we all have a different interpretation of stress these days.  For Euroleaders stress is a lazy stroll down Soft-Growth Lane, hooking a chilled-out right up Minor-Stock-Market-Contraction Street, before sauntering home down No-Fiscal-Crisis-To-See-Here Boulevard.

To most outside the Brussels Bubble however the bank stress tests were about as credible as Barack Obama saying he believes in the market, or Jacob Zuma sticking up for abstinence and condoms, it just doesn’t stack up.  Boy, the stress testers really turned the screws on those banks in their simulation models.  The worst case scenario looks like a mild economic headache rather than the actual worst case shock you would expect in a credible test.  After all, Eurozone members have been teetering on the brink of outright default which could potentially precipitate one of the biggest debt contagions of our time…surely there’s room for an ever-so-slightly more bearish simulation model chaps?

Here’s what Nic Lenoir of ICAP had to say on Zero Hedge: [HA emphasis]

“The European stress test today was a very very sad buffoonery to witness. Firstly the worst case scenario is a 3% GDP contraction and a 20% equity market sell-off. Let’s be frank if GDP contracted in Europe by 3% stocks would fall a bit more than 20%. More importantly, as 20% correction would leave the market clear by 33% above the lows of 2009. You would think the worst case scenario would be at least to revisit these lows. So basically the worst case scenario is not really credible as a “worst” case. Secondly the test focused strictly on the mark-to-market holdings of sovereign bonds. That is like sizing up an iceberg using only the tip. Spanish banks for example are ridden with housing inventories that are most likely marked at the 2006/2007 highs, and all that is happily excluded from the test, as well as accrual accounting books. The fact that they had to resort to truncating the scope so much given a relatively mild worst case assumption tells you how much head scratching must have gone on to make this look half way decent. It even felt like they invented some random unknown banks that failed just to make it legit. Solid work I must say, and on a summer Friday with no volume and syndicated desks using algos to push up the tape, the reception by the market looks quite grand on paper. The fact sadly is that no one cared today and there is not one reasonably informed investor out there who doesn’t see this for what it is: a sad joke. Unfortunately when everybody gives up on the market and it melts up for no reason, I think we are really worst off than if we took the pain we deserve now and deal with the real state of affairs. This expensive extension of a broken system will only make it worse in the end.”

Sad but true.  However, I don’t quite know why all these bright pundits and traders feel so bitter and twisted about all this MOPE.  Did anyone really expect anything different.  The Euroweenies in Brussels and Frankfurt were never going to produce anything that looked remotely bad in these stress tests.  C’mon, you’re scrambling out of a sovereign debt crisis, your central bank has just had to sell what was left of its prudent soul in order to morph unavoidably into the Fed and bailer-outer-of-last-resort, your Eurozone periphery is in a debt crisis just a bad as any of the PIIGS, and political leaders from Berlin to Lisbon are skating like awkward giraffes on wafer thin ice:  What wiggly-worm political leaders and central bankers would ever be so stupid as to allow a big fat FAIL on their exam paper for all the beady eyes of the watching world to see?

No, these farcical stress tests should not come as any surprise.  In fact one could argue that the results are quite realistic.  After all, the ECB is standing ready in the wings to provide effectively limitless euro and dollar liquidity to Eurozone banks (and to banks from their ugly-duckling neighbors in Eastern Europe) via bond and other asset purchase programmes or straight, unadulterated US dollar swap lines with the Fed.  Add to this the IMF and you effectively have European banks backed up by the ECB, the Fed, the IMF and everything in between.  Who cares about bank’s tier 1 capital ratios in bogus or even ruthless scenarios.  JUST PRINT IT UP BOYS!

The point here is not all the eurobank’s resilience in times of stress.  Real stress in Europe without Big Brother’s ballooning bailouts would send quakes through the banking system that would send shivers down the fossilised spines of T-Rex.  The point here is that banking failure is not an option.  Period.  Central bankers and political leaders will not allow it for as long as they can.

As HumanAction has been bellowing for a long time now: it’s bailouts-to-infinity-world and QE2 is on its way.  Whether central bankers admit it or not, the printing presses are being used at every turn to fix a profoundly broken system. 

Ask Messers Mugabe and Gono how that turns out.