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.