Notes From Underground: Why Draghi Needs to Phony the Impending AQR Results

In the mid-October the ECB will announce the results of the Asset Quality Review (AQR), which is a bank stress test by another name. The ECB has measured the riskiness of the European domestic banking system in an effort to measure how much capital banks will need to raise to prevent systemic solvency problems. It is an act of absurdity in some regards because many of Europe’s banks have bought huge amounts of sovereign debt (i.e. Italian and Spanish banks purchasing Italian and Spanish bonds and notes) because they carry a zero risk weighting, requiring no reserves. The problem is that the banks’ assets hide the poor financial health of the banking sector. While European governments are able to borrow at ridiculous rates, private individuals are not able to access credit, which keeps the European economy at a standstill. If the bank stress tests don’t show a dire situation then Mario Draghi will be hard pressed to achieve the massive QE program he would like to undertake.

It would be far better for the ECB to fix the results to show a banking system under great stress in order to scare the Germans out of their continued push for austerity. WORSE WILL BE BETTER FOR DRAGHI. If the euro reacts negatively to failed AQRs, that will be no problem. European financial stocks may take a beating but they have been poor performers (see Deutsche Bank). President Draghi is in a terrible situation as he is caught between French and Italian demands for a weaker euro and more QE, and German concerns about ECB violations of its mandate and demands for more budget austerity. The G-20 meets this week and it will certainly be pressing for some European countries to be more active in ramping up fiscal spending while putting pressure on the ECB to be more proactive on QE. It’s time for Draghi to hire some French chefs to help cook the books.

***In a reflection on the continuing strains in Europe, Hans Michelbach, one of Chancellor Merkel’s allies in the Christian Social Union (CSU) warned over the weekend that Mario Draghi is turning the ECB into a “junk bank.” Germany is continually under attack for preventing a U.S.-style QE program, but with no harmonized fiscal authority like the U.S. Treasury to backstop the ECB‘s balance sheet, Germany is the deep pocket of last resort. If France and Italy want the German’s to be the creditor of the ECB maybe they should pledge their GOLD reserves as collateral. Now’s the time for those gold-backed bonds.

***Question: If the U.S. stock markets reflect genuine economic growth why do the bank stocks remain so lackluster? If the global growth story has any credibility why do the Japanese and other global bank stocks perform so poorly? As all the talking heads look for “cheap” stocks to support their bullish scenarios why don’t they purchase financial stocks? Yes, I am well aware that Dodd-Frank and other regulations have hampered the banks but that has been an old story. Besides, all banks are not so overly regulated so lending growth ought to be somewhere in the system. Just something to think about as we head into the fourth quarter.

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15 Responses to “Notes From Underground: Why Draghi Needs to Phony the Impending AQR Results”

  1. arthur Says:

    Draghi’s plan: If there are no signs soon that inflation will pick up, QE is next on the list.

  2. andrew Says:

    They better hurry and pledge that Gold. Goldman and their proprietary trading software are on a mission to drive Gold to zero

  3. yra Says:

    Arthur–the inflation argument is nice but if German inflation rises because of weak Euro–how will Draghi navigate id inflation is much lower in the others

  4. arthur Says:

    … everyone has a plan ’till they get punched in the mouth (Mike Tyson)… German politics makes full QE hard for Mr Draghi to discuss.

  5. Chicken Says:

    Counting on the greater fool theory to work it’s magic charm, the majority will be joining the party at the top, not the bottom?

    Unfortunately it’s not what we know that counts, what counts is what we’re not allowed to know.

  6. yra Says:

    Arthur–I have used the Tyson quote and believe in its wisdom—-but Germany has the “gold” and their punch and ability to take a punch is greater then most in Europe

  7. ShockedToFindGambling Says:

    Yra- You said…..Question: If the U.S. stock markets reflect genuine economic growth why do the bank stocks remain so lackluster? If the global growth story has any credibility why do the Japanese and other global bank stocks perform so poorly? As all the talking heads look for “cheap” stocks to support their bullish scenarios why don’t they purchase financial stocks?

    My guess is that most money center banks still have so many bad assets, that if you did a real mark to market and disclosed the results, no one would buy them.

  8. asherz Says:

    “…but Germany has the “gold”. It has it but much is stored at 33 Liberty Street. Is it really there? There hasn’t been an audit in decades and Germany’s request for 300 tons delivery was shockingly given a 7 year delivery date. Only 5 tons was shipped in 2013.
    Another example of not looking into anything which might result in creating tremors in the House of Cards.
    How good is this Warehouse Receipt? Anybody old enough to remember Tino De Angelis?

  9. arthur Says:

    This is why George Soros & Co. says (right or wrong) that Germany must accept Eurobonds or leave the European common currency zone.

  10. Joe Says:

    I second Shocked’s opinion re bank stocks, and want to add I often wonder why raw material and metals, and other providers of “stuff” haven’t joined in all the fun. Does recent report that ZINC is in short supply simply signal that the vitamin supplement industry is soft and helping reduce zinc demand?

  11. Chicken Says:

    XLF has doubled over the past few years, a pretty nice gain IMO.

  12. Yra Says:

    Arthur–you are right on soros but his call is predicated on a central authority forcing the Eurobonds upon a German public and that is a problem because the German Constitutional Court has warned about its legality which is why I wrote the piece on referenda last week

  13. arthur Says:

    Yes, I know. Germans side with Immanuel Kant, believing that nothing works except through law, and are horrified when the ECB strays from its narrow mandate. “Breaking the rules destroys trust,” warns Ralph Brinkhaus, a Bundestag member from the centre-right party of Chancellor Angela Merkel

  14. Dustin L. Says:

    Yra- I have long thought that the US Treasury’s fiscal authority underwriting the Fed’s balance sheet while formally seems important, in reality adds little credibility. Who thinks the Tresaury would step into to absorb balance sheet losses when the Fed could just “print” it away? When we are talking the size of the current Fed balance sheet and the tenuous position of the US Governments finances in the long-run, surely no one would trust the Fed holding their reserves if they didn’t have the power to create money. While the ECB is a different animal especially with the Bundesbank as a constant obstacle, in my view the ECB’s balance sheet is supported by the same powers as with the Fed, money creation. So the problem for the ECB is not the ability to credibly absorb a potential loss (of course the currency affects are a story on it’s own) but rather political as you have so often and effectively pointed out before. It’s the Bavarian Burghers, not the lack of a central fiscal authority, that is holding back Draghi. Your point on gold backed bonds has not been lost on me though. Perhaps the barbarous relic is held to close to heart to be risked by insolvent parties?

  15. Yra Says:

    Dustin L–thanks so very much and your point is well taken but the ECB may be able to print money but the conservative nature of its Bundesbank DNA is not something to be taken lightly–

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